Scenario A:

Real Estate Purchase Price: $100,000

Equity invested: $80,000

Debt: $20,000

Interest Rate: 10%

Sale price after 1 year: $150,000

Question:

What is the leverage ratio?

What is the rate of return for the year during this period of increasing asset prices?

Scenario B:

Real Estate Purchase Price: $100,000

Equity invested: $10,000

Debt: $90,000

Interest Rate: 10%

Sale price after 1 year: $150,000

What is the leverage ratio?

What is the rate of return for the year during this period of increasing asset prices?

Based on your results in scenarios A and B, what is the relationship between leverage and rates of return during periods of rising asset prices?

Group of answer choices

None of the available answers

Rates of return are amplified in a positive direction when leverage is increased during periods of rising asset prices. This is due to the fact that the amount of equity invested is becoming smaller as leverage is increased. This means that the denominator in the rate of return calculation ratio is shrinking by a greater percentage than the numerator. Mathematically this leads to an increase in the rate of return calculation ratio in a positive direction.

Rates of return are increased in a positive direction when leverage is increased during periods of rising asset prices. This is because the amount of debt is decreased.

Rates of return are amplified in a negative direction when leverage is increased during periods of rising asset prices. This is due to the fact that the amount of equity invested is becoming larger as leverage is increased. This means that the denominator in the rate of return calculation ratio is increasing by a greater percentage than the numerator. Mathematically this leads to an increase in the rate of return calculation ratio in a positive direction.

Scenario C:

Real Estate Purchase Price: $100,000

Equity invested: $90,000

Debt: $10,000

Interest Rate: 10%

Sale price after 1 year: $20,000

What is the leverage ratio?

What is the rate of return for the year during this period of decreasing asset prices?

Scenario D:

Real Estate Purchase Price: $100,000

Equity invested: $5,000

Debt: $95,000

Interest Rate: 10%

Sale price after 1 year: $20,000

What is the leverage ratio?

What is the rate of return for the year during this period of decreasing asset prices?

Question:

Based on your results in scenarios C and D, what is the relationship between leverage and rates of return during periods of decreasing asset prices?

Group of answer choices

Rates of return are amplified in a positive direction when leverage is increased during periods of rising asset prices. This is due to the fact that the amount of equity invested is becoming smaller as leverage is increased. This means that the denominator in the rate of return calculation ratio is shrinking by a greater percentage than the numerator. Mathematically this leads to an increase in the rate of return calculation ratio in a positive direction.

Rates of return are amplified in a negative direction when leverage is increased during periods of decreasing asset prices. This is due to the fact that the amount of equity invested is becoming smaller as leverage is increased. This means that the denominator in the rate of return calculation ratio is shrinking by a greater percentage than the numerator. Mathematically this leads to an increase in the rate of return calculation ratio in a negative direction.

Rates of return are increased in a negative direction when leverage is increased during periods of rising asset prices. This is because the amount of debt is decreased.

None of the available answers

Question 

Based on all of the scenarios examined during periods of rising and decreasing asset prices, what can we say overall about the effect of leverage on rates of return?

Group of answer choices

Increasing leverage amplifies rates of return in a negative direction during periods of rising asset prices, and amplifies rates of return in a positive direction during periods of declining asset prices. This can lead to insolvency.

Increasing leverage amplifies rates of return in a positive direction during periods of rising asset prices, and amplifies rates of return in a negative direction during periods of declining asset prices.

None of the available answers

Leverage has no impact on rates of return.