Leverage ratio for calculating Margins

CFA Level I
#1

Hello All,

If leverage ratio = 2.5, then investment in equities = 40% on 100% position. In other words, 60% will be borrowed debt. What would happen to this leverage ratio if investment in equities were 0? Will leverage ratio be infinity? :slight_smile: Mathematically, that may sound a bit odd. Just curious.

I would appreciate your thoughts.

Thanks

#2

Hmm, how can a firm be shareholders- less? Who own the company then?

#3

If equity is 0 and there was an investment, it’s apprently 100% debt.

#4

Yes, if the investment went to zero, the leverage ratio would be infinite.

That’s why there’s a maintenance margin.

#5

Thanks S2000magician

#6

He’s asking about buying stock on margin, not about a company having no shareholders.

#7

You’re welcome.

#8

S2000magician — Why can’t we have a company with 100% debt? As in, I could borrow money using bonds and open my own coffee shop. Isn’t it? I would appreciate if you could comment on this.

Thanks in advance.

#9

In theory you could have a corporation without any stock outstanding (the corporation buys up all outstanding shares as treasury stock), but you’d likely still have equity through retained earnings. Unless it’s a really lousy coffee shop.

In practice, I believe that it is not legal for a corporation to purchase 100% of its outstanding shares as treasury stock.

#10

Thank you S2000magician!

#11

You’re welcome.