Banking 10 - Introduction to Leverage Flashcards
leverage = ?
how much assets do you control with a certain amount of equity
the ability to control an enhanced amount of assets with a smaller number of equity
how is leverage expressed?
as a ratio
assets : equity leverage
e.g., assets = 1,000, equity = 300
10:3 leverage
other types of leverage ratio?
debt : equity leverage
return on assets calculation?
total income/total assets
expressed as a %
e.g., 100,000 in income / 1,000,000 in assets = 10% return on assets (ROA)
two ways of financing assets?
debt and equity
return on equity calculation?
total income / total equity
expressed as a %
what is leverage in simple terms?
allows you to buy more stuff by borrowing
does leverage increase risk?
yes
risk element is due to the fact that the money from leverage is borrowed
if they are not able to pay back the leveraged amount, they’re in trouble (e.g., if they cant make a return on the asset)
why do banks leverage?
to buy more assets
who do derivatives offer safety to?
only the seller
as long as the buyer has money to honour the contract
derivatives?
an arrangement/contract that derives its value from an underlying asset (commodity, security, currency)
examples of derivatives?
futures contracts
options contracts
swaps
