Different approaches for calculating leverage level
Please click to view the illustrative examples:
- Basic demonstration of difference between the leverage levels calculated under the sum of notionals approach and the commitment approach
- A fund that uses FDIs extensively for investment purposes
- A fund that uses FDIs extensively for hedging purposes
(1) Basic demonstration of difference between the leverage levels calculated under the sum of notionals approach and the commitment approach
Background
Net asset value of the fund portfolio: $1,000,000
The fund portfolio contains the following FDIs:
| Notional value of FDIs | Market value of FDI’s underlying assets | |
| Long futures (for investment purpose) | $750,000 | $780,000 |
| Short futures (for investment purpose) | $250,000 | $230,000 |
| Long forwards (for hedging purpose) | $100,000 | $100,000 |
Leverage level of the fund via FDI
-
Under the sum of notionals approach:
(The level of leverage of the fund is calculated as the sum of the notional values of all FDIs entered into by the fund expressed as a percentage of the fund’s net asset value)Leverage level
= (Sum of notionals of the derivatives) / (Fund’s net assets)
= ($750,000 + $250,000 + $100,000) / $1,000,000
= 110% -
Under the commitment approach:
(The level of leverage of the fund calculation excludes the long forwards position, which is for hedging purpose, and assuming the long and short futures positions satisfy the conditions that allow for netting under the commitment approach)Leverage level
= (Sum of market value of the underlying assets, taking into account the netting and hedging arrangement) / (Fund’s net assets)
= ($780,000 - $230,000 + $0) / $1,000,000
= 55%
(2) A fund that uses FDIs extensively for investment purposes
Background
Net asset value of the fund portfolio: $1,000,000
The fund portfolio contains the following FDIs:
| Notional value of FDIs | Market value of FDI’s underlying assets | |
| Long futures (for investment purpose) | $5,000,000 | $4,700,000 |
| Short futures (for investment purpose) | $1,000,000 | $1,200,000 |
| Long forwards (for hedging purpose) | $100,000 | $100,000 |
Leverage level of the fund via FDI
-
Under the sum of notionals approach:
Leverage level
= (Sum of notionals of the derivatives) / (Fund’s net assets)
= ($5,000,000 + $1,000,000 + $100,000) / $1,000,000
= 610% -
Under the commitment approach:
Leverage level
= (Sum of market value of the underlying assets, taking into account the netting and hedging arrangement) / (Fund’s net assets)
= ($4,700,000 - $1,200,000 + $0) / $1,000,000
= 350%
In this example, for a fund that uses FDIs extensively for investment purposes and if such FDI positions satisfy the conditions that allow for netting under commitment approach, the leverage level calculated under the sum of notionals approach is significantly greater than that calculated under the commitment approach.
(3) A fund that uses FDIs extensively for hedging purposes
Background
Net asset value of the fund portfolio: $1,000,000
The fund portfolio contains the following FDIs:
| Notional value of FDIs | Market value of FDI’s underlying assets | |
| Long futures (for investment purpose) | $1,000,000 | $950,000 |
| Long forwards (for hedging purpose) | $5,000,000 | $5,000,000 |
| Long swaps (for hedging purpose) | $3,000,000 | $3,000,000 |
Leverage level of the fund via FDI
-
Under the sum of notionals approach:
Leverage level
= (Sum of notionals of the derivatives) / (Fund’s net assets)
= ($1,000,000 + $5,000,000 + $3,000,000) / $1,000,000
= 900% -
Under the commitment approach:
Leverage level
= (Sum of market value of the underlying assets, taking into account the netting and hedging arrangement) / (Fund’s net assets)
= ($950,000 + $0 + $0) / $1,000,000
= 95%
In this example, for a fund that uses FDIs extensively for hedging purposes, the leverage level calculated under the sum of notionals approach is significantly greater than that calculated under the commitment approach.
