Reading 29: Fixed Income Portfolio Management - Part II－LO returns, 2008

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CFA Institute Area 8-11, 13: Asset Valuation
Session 9: Portfolio Management of Global Bonds and Fixed Income Derivatives
Reading 29: Fixed Income Portfolio Management - Part II
LOS a: Evaluate the effects of leverage on portfolio returns.

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Which of the following is an advantage of leverage? Leverage:

A) decreases the risk for a given return potential.

B) increases both the return potential and decreases the risk.

C) increases the return potential without incurring larger risk.

D) magnifies the return from a security for a given price change.

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Answer and Explanation

Leveraging increases the return potential but also increases the risk, resulting in a wider range of possible outcomes.

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Which of the following best characterizes leveraging? Leveraging involves:

A) writing options.

B) borrowing funds to implement a trade.

C) exploiting an arbitrage opportunity.

D) exploiting mispricings in the market.

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Answer and Explanation

Leverage refers to the use of borrowed funds to purchase a portion of the securities in a portfolio. A leverage-based strategy is used with the objective of earning a return over and above the cost of borrowed funds.

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Which of the following statements regarding leverage is FALSE?

A) Leverage refers to using borrowed funds to purchase a portion of the securities in the portfolio.

B) As leverage increases, return volatility increases.

C) A leverage-based strategy decreases portfolio returns when the return on the strategy is greater than the cost of borrowed funds.

D) Leverage is beneficial only when the strategy earns a return greater than the cost of borrowing.

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Answer and Explanation

A leverage-based strategy increases, not decreases portfolio returns when the return on the strategy is greater than the cost of borrowed funds.

A leverage-based strategy increases, not decreases portfolio returns when the return on the strategy is greater than the cost of borrowed funds.