Question

Catherina makes an investment in the Australian equity market index using her own fund of $200,000 and a margin loan that provides $100,000. The following table is prepared by Catherina. If there is a 40% rise in her portfolio value, compute the net portfolio value and the loan to value (LVR) ratio for her geared portfolio. What is the rate of return of her investment with gearing?

	Geared Portfolio	Ungeared Portfolio
Initial Investment	200,000	200,000
Borrowed Fund	100,000	0
Portfolio Value	300,000	200,000

Answer 1

Solution a) For geared portfolio:

Initial portfolio value = $300,000

Rise in the portfolio value = 40%

Thus, ending portfolio value = $300,000*(1+40%)

= $420,000

Solution b) Loan to value Ratio (LVR) = Value of loan/Portfolio value

Initial LVR = 100000/300000 = 33.33%

Final portfolio value = $420,000

LVR = 100000/420000 = 23.81%

Solution c) Initial investment = $200000

Loan amount = $100,000

Final portfolio value = $420,000

Equity amount after paying loan = $420,000 - $100,000

= $320,000

Investor rate of return = (320,000 - 200000)/200000

= 120,000/200000

= 0.6 = 60%

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