Australia

Scenarios

Gearing/Margin Lending

QUESTION (Please see attachments)

Question a. Two investors make an investment in the Australian equity market index (ASXZOO). Both investors have $100,000 of their own funds to invest. Investor A obtains a margin loan in the amount of $55,000, while Investor B who is not comfortable with debt, will only invest his own money. Complete the table below to show the effect of the index increasing in value by 50% on the portfolios of both investors. Geared Portfolio Ungeared Portfolio Investor 1 Investor 2 Initial investment Borrowed funds Portfolio value Scenario 1 Portfolio value Less Loans outstanding Net portfolio value % Return on initial investment Loan to Value Ratio (LVR) b. Suppose the index fell by 50%. Complete the table below to show the impact this will have on the positions of both investors. Geared Portfolio Ungeared Portfolio Investor 1 Investor 2 Initial investment Borrowed funds Portfolio value Scenario 2 50% fall in the value of the portfolio Portfolio value Less Loans outstanding Net portfolio value