Leveraged Trading Quiz Exam Quiz 33

To determine the maximum potential loss, we need to calculate the maximum possible exposure. First, we calculate the total value of the shares purchased using leverage: 50,000 shares * £2.50/share = £125,000. The initial margin provided by the investor is £35,000. The leverage ratio is calculated as Total Value / Initial Margin = £125,000 / £35,000 ≈ 3.57. Now, let’s consider the worst-case scenario: the share price falls to zero. In this case, the total value of the shares becomes zero. The maximum potential loss is the initial value of the shares purchased minus any residual value (which is zero in this worst-case scenario). Therefore, the maximum potential loss is equal to the total value of the shares purchased using leverage, which is £125,000, minus the initial margin, which is £35,000. Thus, the maximum potential loss is £125,000 – £35,000 = £90,000. A key consideration in leveraged trading is understanding the amplification of both gains and losses. While the initial margin provides a buffer, the leveraged position exposes the investor to losses far exceeding the initial investment. For instance, imagine a small technology firm whose stock is highly volatile. An investor uses leverage to purchase a significant stake. A negative news event, like a failed product launch, could cause the stock to plummet rapidly. In a non-leveraged scenario, the investor’s loss would be limited to the initial investment. However, with leverage, the loss is magnified, potentially wiping out the initial margin and resulting in a substantial debt to the broker. Regulatory frameworks, like those under the CISI, mandate disclosure of these risks and often impose margin requirements to mitigate systemic risk and protect investors from excessive losses. Furthermore, brokers implement risk management systems that monitor positions and trigger margin calls if the value of the collateral falls below a certain threshold.

The question tests the understanding of how leverage affects the break-even point in trading options. The break-even point is where the profit equals the premium paid. When leverage is applied through options, the potential profit is magnified, but so is the risk. The trader needs to correctly calculate the break-even point considering the premium, the leverage effect of the option, and the initial investment. Here’s the breakdown of the calculation: 1. **Calculate the total premium paid:** The trader buys 10 call option contracts, and each contract covers 100 shares. So, the total number of shares covered is \(10 \times 100 = 1000\) shares. The premium is £2 per share, so the total premium paid is \(1000 \times £2 = £2000\). 2. **Determine the break-even point:** The break-even point for a call option is the strike price plus the premium paid per share. The strike price is £50, and the premium paid is £2 per share. Therefore, the break-even point is \(£50 + £2 = £52\). 3. **Calculate the percentage increase needed to reach the break-even point:** The percentage increase is calculated from the initial share price of £48 to the break-even price of £52. The increase in price is \(£52 – £48 = £4\). The percentage increase is \(\frac{£4}{£48} \times 100\). 4. **Calculate the percentage:** \(\frac{4}{48} \times 100 = 8.33\%\). Therefore, the share price needs to increase by 8.33% for the trader to break even on the call option investment. Imagine you are starting a small business with a £10,000 loan (leverage). If your business generates only £500 profit in the first year, it might not seem like much. However, if you had only invested £2,000 of your own money and borrowed the remaining £8,000, that £500 profit represents a much larger return on your initial investment. Similarly, options trading uses leverage to control a large number of shares with a relatively small investment (the premium). This magnification of potential returns also magnifies the potential for losses. The break-even point is crucial because it shows the minimum price movement needed for the investment to start generating profit, highlighting the inherent risk and reward associated with leverage.

The question assesses understanding of leverage ratios, specifically the financial leverage ratio, and its impact on a company’s Return on Equity (ROE) under different economic scenarios. The financial leverage ratio is calculated as Total Assets divided by Total Equity. ROE is calculated as Net Income divided by Total Equity. The relationship between leverage, ROA (Return on Assets), interest expense, and tax rate impacts ROE. When ROA exceeds the after-tax cost of debt, leverage enhances ROE. First, calculate the financial leverage ratio: Total Assets / Total Equity = £5,000,000 / £2,000,000 = 2.5. Next, calculate the ROA for each scenario: * Scenario 1 (Boom): £600,000 / £5,000,000 = 0.12 or 12% * Scenario 2 (Normal): £400,000 / £5,000,000 = 0.08 or 8% * Scenario 3 (Recession): £100,000 / £5,000,000 = 0.02 or 2% Calculate interest expense: £3,000,000 * 0.05 = £150,000 Calculate earnings before tax (EBT) for each scenario: * Scenario 1: £600,000 – £150,000 = £450,000 * Scenario 2: £400,000 – £150,000 = £250,000 * Scenario 3: £100,000 – £150,000 = -£50,000 Calculate net income (NI) for each scenario (assuming a 20% tax rate): * Scenario 1: £450,000 * (1 – 0.20) = £360,000 * Scenario 2: £250,000 * (1 – 0.20) = £200,000 * Scenario 3: -£50,000 * (1 – 0.20) = -£40,000 (Tax credit) Calculate ROE for each scenario: * Scenario 1: £360,000 / £2,000,000 = 0.18 or 18% * Scenario 2: £200,000 / £2,000,000 = 0.10 or 10% * Scenario 3: -£40,000 / £2,000,000 = -0.02 or -2% The correct answer is Scenario 1: 18%, Scenario 2: 10%, Scenario 3: -2%. A key takeaway is that leverage amplifies both gains and losses. In the boom scenario (high ROA), leverage significantly increases ROE. Conversely, in the recession scenario (low ROA), leverage exacerbates the negative impact, leading to a negative ROE. This demonstrates the risk-reward trade-off associated with leverage. The company needs to carefully assess the potential for both positive and negative outcomes before employing significant financial leverage.

The question assesses the understanding of how changes in initial margin requirements affect the leverage available to a trader and the resulting impact on their trading positions. A higher initial margin requirement reduces the amount of leverage a trader can employ, as they need to allocate more of their capital upfront. Conversely, a lower initial margin requirement increases the available leverage. The formula to calculate the maximum position size is: Maximum Position Size = Trading Capital / Initial Margin Requirement. In this scenario, the initial margin requirement increases from 2% to 5%. The trader has £50,000 in trading capital. Initial Scenario: Initial Margin Requirement = 2% = 0.02 Maximum Position Size = £50,000 / 0.02 = £2,500,000 New Scenario: New Margin Requirement = 5% = 0.05 New Maximum Position Size = £50,000 / 0.05 = £1,000,000 The difference in maximum position size is: £2,500,000 – £1,000,000 = £1,500,000. The percentage change in maximum position size is: \[\frac{£1,000,000 – £2,500,000}{£2,500,000} \times 100 = -60\%\] Therefore, the trader’s maximum position size decreases by £1,500,000, representing a 60% reduction in leverage. This means the trader can now control a significantly smaller position with the same amount of capital due to the increased margin requirement. This example demonstrates the inverse relationship between margin requirements and leverage. A broker increasing margin requirements effectively reduces the potential profit and loss exposure a trader can take on with a given amount of capital, aligning with risk management objectives.

The question assesses understanding of leverage ratios, specifically the Debt-to-Equity ratio, and its implications for a firm operating under UK regulatory constraints regarding financial leverage. The Debt-to-Equity ratio is calculated as Total Debt / Shareholders’ Equity. A higher ratio indicates greater financial leverage. UK regulations often impose limits on the amount of leverage a firm can employ to protect investors and maintain financial stability within the market. In this scenario, we need to first calculate the initial Debt-to-Equity ratio. The initial debt is £25 million and the initial equity is £50 million, resulting in a Debt-to-Equity ratio of 0.5. The company then takes on an additional £15 million in debt, bringing the total debt to £40 million. To maintain the *initial* Debt-to-Equity ratio of 0.5, the equity must increase proportionally. Let \(x\) be the required increase in equity. We set up the equation: \[\frac{40,000,000}{50,000,000 + x} = 0.5\] Solving for \(x\): \[40,000,000 = 0.5(50,000,000 + x)\] \[40,000,000 = 25,000,000 + 0.5x\] \[15,000,000 = 0.5x\] \[x = 30,000,000\] Therefore, the company must raise an additional £30 million in equity to maintain its original Debt-to-Equity ratio. If the company only raised £20 million in equity, the new Debt-to-Equity ratio would be \[\frac{40,000,000}{50,000,000 + 20,000,000} = \frac{40,000,000}{70,000,000} \approx 0.57\]. Since 0.57 is greater than the company’s acceptable limit of 0.55, the company would be in violation of its financial covenants and UK regulations. The company needs to raise an additional £10 million to reach the required £30 million equity.

The core concept being tested here is the interplay between leverage, margin requirements, and the potential for margin calls, specifically within the context of a UK-based leveraged trading account subject to FCA regulations. The question requires understanding how changes in asset value impact the available margin, and how leverage magnifies these effects. The calculation involves determining the initial equity, the effect of the asset depreciation on the equity, and whether the new equity level breaches the maintenance margin requirement, thus triggering a margin call. First, calculate the initial equity: £20,000 cash + £80,000 initial loan = £100,000 total investment. With a 5:1 leverage, the trader controls assets worth 5 * £100,000 = £500,000. Next, determine the impact of the 12% depreciation: £500,000 * 0.12 = £60,000 loss in asset value. Now, calculate the new asset value: £500,000 – £60,000 = £440,000. The loan amount remains constant at £400,000 (5 times the cash amount of £80,000). Calculate the new equity: £440,000 (new asset value) – £400,000 (loan) = £40,000. Finally, assess if a margin call is triggered. The maintenance margin is 20% of the asset value: 0.20 * £440,000 = £88,000. Since the new equity (£40,000) is less than the maintenance margin (£88,000), a margin call is triggered. The margin call amount is the difference between the maintenance margin and the actual equity: £88,000 – £40,000 = £48,000. Therefore, the trader will receive a margin call for £48,000.

The question assesses the understanding of leverage ratios, specifically focusing on the debt-to-equity ratio and its implications for a company undergoing a strategic shift. It tests the candidate’s ability to analyze how changes in debt and equity affect the leverage ratio and, consequently, the company’s financial risk profile. The debt-to-equity ratio is calculated as total debt divided by total equity. In the initial state, the company has a debt-to-equity ratio of \( \frac{7,500,000}{15,000,000} = 0.5 \). The company then issues new shares, increasing equity by £5,000,000 to £20,000,000. It uses £3,000,000 of this new equity to repay debt. The new debt level is £7,500,000 – £3,000,000 = £4,500,000. The new debt-to-equity ratio is therefore \( \frac{4,500,000}{20,000,000} = 0.225 \). To express this as a percentage, we multiply by 100: 0.225 * 100 = 22.5%. This calculation demonstrates how a strategic decision to reduce debt using equity financing can significantly lower a company’s leverage ratio, thus reducing its financial risk. The scenario is designed to mimic a real-world situation where a company is actively managing its capital structure to improve its financial health and attractiveness to investors. It moves beyond simple memorization of the formula and tests the ability to apply the concept in a practical context. The plausible distractors are designed to reflect common errors in calculating the debt-to-equity ratio, such as failing to account for both the increase in equity and the decrease in debt, or misinterpreting the impact of the strategic shift on the company’s overall financial risk. The question requires a nuanced understanding of financial leverage and its implications for corporate finance.

Let’s break down how to calculate the potential loss and profit, considering the margin, leverage, commission, and interest. First, determine the initial margin requirement: 5% of £250,000 is \(0.05 \times 250000 = £12,500\). This is the amount Sarah needs in her account to open the position. Next, calculate the commission: 0.1% of £250,000 is \(0.001 \times 250000 = £250\). This is paid both when opening and closing the position, so the total commission is \(£250 \times 2 = £500\). Now, let’s calculate the interest expense. The position is held for 7 days at an annual interest rate of 4% on the full £250,000. The daily interest rate is \(0.04 / 365\). So, the total interest is \((0.04 / 365) \times 7 \times 250000 \approx £19.18\). The potential loss is capped at the initial margin plus commissions and interest, as that’s all Sarah has at risk. However, the question asks for the net loss or profit. If the share price falls by 6%, the loss on the £250,000 position is \(0.06 \times 250000 = £15,000\). The total loss is the £15,000 price decrease, plus £500 commission, plus £19.18 interest, totaling £15,519.18. If the share price rises by 6%, the profit on the £250,000 position is \(0.06 \times 250000 = £15,000\). The total profit is the £15,000 price increase, minus £500 commission, minus £19.18 interest, totaling £14,480.82. Therefore, the net difference between the potential loss and profit is \(£14,480.82 – £15,519.18 = -£1,038.36\). This means the potential loss exceeds the potential profit by £1,038.36.

The core of this question lies in understanding how leverage amplifies both potential gains and potential losses, and how margin requirements and available equity influence a trader’s ability to withstand adverse price movements. The calculation involves determining the maximum allowable loss before a margin call is triggered, considering the initial equity, the leverage ratio, and the asset’s price. First, we need to calculate the total position value based on the leverage ratio and initial equity: Position Value = Initial Equity * Leverage Ratio. In this case, Position Value = £20,000 * 20 = £400,000. Next, we need to determine the number of units (contracts, shares, etc.) controlled with this position value. Units = Position Value / Asset Price. In this case, Units = £400,000 / £20 = 20,000 units. Now, calculate the maintenance margin requirement. Maintenance Margin = Position Value * Maintenance Margin Percentage. In this case, Maintenance Margin = £400,000 * 0.05 = £20,000. The available equity before a margin call is triggered is the difference between the initial equity and the maintenance margin: Available Equity = Initial Equity – Maintenance Margin. In this case, Available Equity = £20,000 – £20,000 = £0. This indicates that even a small loss will trigger a margin call. Therefore, the maximum allowable loss per unit before a margin call is triggered is calculated by dividing the available equity by the number of units: Allowable Loss per Unit = Available Equity / Units. In this case, Allowable Loss per Unit = £0 / 20,000 = £0. This means that the trader will receive a margin call with even a tiny loss, as the initial equity is exactly equal to the maintenance margin requirement. In a real-world scenario, this highlights the extreme risk of using very high leverage. Even minor price fluctuations can trigger margin calls, potentially wiping out the trader’s initial investment. The example showcases the importance of carefully considering margin requirements and leverage ratios when trading leveraged products.

The question assesses understanding of the impact of changes in margin requirements on a leveraged trading position, specifically focusing on the interaction between initial margin, maintenance margin, and available equity. The calculation determines if a margin call is triggered after a price decline. First, calculate the initial equity: £20,000. Next, calculate the position value: 10,000 shares * £2.50/share = £25,000. Then, calculate the initial margin required: 20% * £25,000 = £5,000. Since the initial equity is £20,000, and the initial margin required is £5,000, the excess equity is £15,000. Now, calculate the new position value after the price decline: 10,000 shares * £2.00/share = £20,000. Calculate the maintenance margin required: 15% * £20,000 = £3,000. Calculate the equity after the price decline: Initial Equity – (Price Decline * Number of Shares) = £20,000 – ((£2.50 – £2.00) * 10,000) = £20,000 – £5,000 = £15,000. To determine if a margin call is triggered, compare the equity after the price decline to the maintenance margin required. In this case, the equity (£15,000) is greater than the maintenance margin (£3,000). Therefore, no margin call is triggered. The crucial aspect is understanding that the maintenance margin is calculated on the *current* value of the position, not the initial value. A common error is to calculate the margin call based on the initial margin, or to incorrectly calculate the equity after the price decline. The large initial equity relative to the position size is designed to test the understanding of how much buffer the trader has before a margin call is triggered.

The question assesses the understanding of how leverage impacts margin requirements and the potential consequences of failing to meet those requirements. It requires calculating the initial margin, understanding the maintenance margin, and determining the price at which a margin call will occur. First, calculate the initial margin: 10,000 shares * £5.00/share * 50% = £25,000. This is the initial amount required in the account. Next, determine the total value of the shares at the point of margin call. A margin call occurs when the equity in the account falls below the maintenance margin. The equity in the account is the value of the shares minus the loan amount. The loan amount is the initial value of the shares minus the initial margin: (10,000 shares * £5.00/share) – £25,000 = £25,000. Let ‘P’ be the price at which a margin call occurs. The equity at the margin call point is 30% of the value of the shares. So: (10,000 * P) – £25,000 = 0.30 * (10,000 * P). Solving for P: 10,000P – 25,000 = 3,000P => 7,000P = 25,000 => P = £25,000 / 7,000 = £3.57 (rounded to the nearest penny). The margin call price is £3.57. Failing to meet a margin call can lead to the forced liquidation of assets to cover the loan. The brokerage firm is legally obligated to minimize its own risk, even if it means selling the investor’s assets at a loss. This forced liquidation can result in significant financial losses for the investor. The investor’s account will be debited for any losses incurred during liquidation. Furthermore, under UK regulations and CISI guidelines, firms must adhere to strict procedures regarding margin calls, including providing timely notification to clients and allowing a reasonable opportunity to deposit additional funds.

The question assesses the understanding of how leverage impacts the margin requirements in a trading account, specifically when trading CFDs (Contracts for Difference). CFDs are leveraged products, meaning a trader only needs to deposit a fraction of the total trade value as margin. The initial margin is the amount required to open a position, and the maintenance margin is the minimum amount that must be maintained in the account to keep the position open. If the account balance falls below the maintenance margin, a margin call is triggered, and the trader needs to deposit additional funds or close the position. In this scenario, the trader uses a significant portion of their available margin, increasing the risk of a margin call if the market moves against them. A relatively small adverse price movement can erode the account balance to below the maintenance margin level. The calculation involves determining the profit/loss point at which the account equity reaches the maintenance margin level, triggering a margin call. Here’s the breakdown of the calculation: 1. **Initial Margin Used:** £80,000 2. **Available Equity:** £100,000 3. **Maintenance Margin Requirement:** 80% of initial margin used = 0.80 * £80,000 = £64,000 4. **Equity Buffer Before Margin Call:** Available Equity – Maintenance Margin = £100,000 – £64,000 = £36,000 5. **Price Change to Trigger Margin Call:** The trader can withstand a loss of £36,000 before a margin call is triggered. Since each CFD contract represents £10 of the underlying asset, the number of contracts traded is 8,000,000 / 10 = 800,000 contracts. The loss per contract to trigger a margin call is £36,000 / 800,000 = £0.045. 6. **Therefore, a price decrease of £0.045 per contract will trigger a margin call.** The correct answer reflects this calculation. The incorrect options represent common errors, such as calculating the margin call based on the total trade value instead of the margin used, misunderstanding the maintenance margin requirement, or incorrectly calculating the number of contracts.

The core of this question revolves around understanding how leverage impacts both potential profits and potential losses, particularly when dealing with margin calls and forced liquidations. The maintenance margin is the minimum equity an investor must maintain in their margin account. When the equity falls below this level, a margin call is triggered. If the investor fails to deposit additional funds to bring the equity back up to the initial margin, the broker will liquidate positions to cover the shortfall. The formula to determine the price at which a margin call will occur is: Margin Call Price = Purchase Price * ((1 – Initial Margin) / (1 – Maintenance Margin)). In this scenario, we need to calculate the price at which a margin call will occur and then determine the loss incurred if the position is liquidated at that price. The initial margin is 50% (0.5) and the maintenance margin is 30% (0.3). The purchase price is £20 per share. Margin Call Price = £20 * ((1 – 0.5) / (1 – 0.3)) = £20 * (0.5 / 0.7) = £20 * (5/7) = £14.29 (rounded to two decimal places). The loss per share at the margin call price is the difference between the purchase price and the margin call price: £20 – £14.29 = £5.71. The total loss is the loss per share multiplied by the number of shares: £5.71 * 10,000 = £57,100. This example illustrates the magnified losses that can occur when using leverage. A relatively small price decline can trigger a margin call, leading to a forced liquidation and substantial losses, especially in large positions. The high leverage amplifies both the potential gains and the potential losses, making risk management crucial. Understanding the relationship between initial margin, maintenance margin, and the price at which a margin calls occur is critical for any trader using leverage. The risk of ruin increases substantially with higher leverage, as even small adverse price movements can trigger a total loss of invested capital.

The question assesses the understanding of leverage ratios, specifically the debt-to-equity ratio, and how changes in asset values impact this ratio and the perceived risk profile of a leveraged trading firm. The scenario involves a firm whose asset values decline due to unforeseen market events, directly affecting the equity portion of the debt-to-equity ratio. The debt-to-equity ratio is calculated as Total Debt / Shareholder’s Equity. In this case, the initial debt-to-equity ratio is 2:1, meaning for every £1 of equity, there’s £2 of debt. The firm has £10 million in debt and, therefore, £5 million in equity. A 30% decline in asset value directly reduces the equity. The assets were initially worth £15 million (£10 million debt + £5 million equity). A 30% decline in assets results in a loss of £4.5 million (£15 million * 0.30). This loss is absorbed by the equity, reducing it from £5 million to £0.5 million (£5 million – £4.5 million). The new debt-to-equity ratio is then calculated using the original debt of £10 million and the new equity of £0.5 million: £10 million / £0.5 million = 20. Therefore, the new debt-to-equity ratio is 20:1. The increased debt-to-equity ratio signifies a much higher level of financial risk. A higher ratio means the company is using more debt to finance its assets, making it more vulnerable to financial distress if it cannot meet its debt obligations. The firm’s creditors will view this as a significant increase in risk, potentially leading to higher borrowing costs or even a reluctance to extend further credit. This is because the firm now has a much smaller equity cushion to absorb any further losses.

Let’s analyze the impact of operational leverage in a brokerage firm providing leveraged trading services. Operational leverage arises from fixed costs in the business. A brokerage with high fixed costs (e.g., technology infrastructure, regulatory compliance teams, office space) relative to variable costs (e.g., transaction processing fees, marketing commissions) has high operational leverage. The degree of operating leverage (DOL) measures the sensitivity of a firm’s operating income (EBIT) to changes in sales. The formula for DOL is: DOL = (Percentage Change in EBIT) / (Percentage Change in Sales) Alternatively, it can be calculated as: DOL = (Sales – Variable Costs) / (Sales – Variable Costs – Fixed Costs) In this scenario, we will calculate the DOL and analyze the implications of a change in trading volume on the brokerage’s profitability. Assume the brokerage has the following financial structure: * Sales (Trading Volume Revenue): £5,000,000 * Variable Costs (Transaction Processing, Commissions): £2,000,000 * Fixed Costs (Technology, Compliance, Rent): £2,000,000 EBIT = Sales – Variable Costs – Fixed Costs = £5,000,000 – £2,000,000 – £2,000,000 = £1,000,000 DOL = (£5,000,000 – £2,000,000) / (£5,000,000 – £2,000,000 – £2,000,000) = £3,000,000 / £1,000,000 = 3 This DOL of 3 means that for every 1% change in sales (trading volume), the brokerage’s EBIT will change by 3%. Now, suppose the trading volume increases by 10%. The new sales would be £5,000,000 * 1.10 = £5,500,000. The new variable costs would be £2,000,000 * 1.10 = £2,200,000. Fixed costs remain constant at £2,000,000. New EBIT = £5,500,000 – £2,200,000 – £2,000,000 = £1,300,000 Percentage Change in EBIT = ((£1,300,000 – £1,000,000) / £1,000,000) * 100% = 30% This confirms the DOL calculation: a 10% increase in sales led to a 30% increase in EBIT (3 * 10% = 30%). The implications of high operational leverage are significant. While it amplifies profits during periods of increasing trading volume, it also magnifies losses during downturns. Therefore, brokerages with high operational leverage must carefully manage their risk and ensure they have sufficient capital reserves to withstand periods of reduced trading activity. Furthermore, they need robust risk management systems to monitor and control the risks associated with leveraged trading, as a sudden market shock could significantly impact their profitability due to the combined effect of leveraged trading positions and high operational leverage.

The question assesses the understanding of how leverage impacts the breakeven point in options trading, specifically within a spread strategy. A call spread involves buying one call option and selling another call option with a higher strike price on the same underlying asset and expiration date. Leverage, in this context, amplifies both potential profits and losses. The breakeven point is calculated differently than a simple long or short position due to the offsetting nature of the spread. First, we need to determine the net premium paid. The trader bought the call option with a strike price of 1500 for £3.50 and sold the call option with a strike price of 1550 for £1.50. The net premium paid is £3.50 – £1.50 = £2.00. The breakeven point for a long call spread is calculated as the lower strike price plus the net premium paid. In this case, the lower strike price is 1500, and the net premium paid is £2.00. Therefore, the breakeven point is 1500 + 2 = 1502. The leverage effect comes into play because a small change in the underlying asset’s price can lead to a larger percentage change in the profit or loss of the spread, relative to the initial investment (the net premium). If the asset price remains below 1500, the trader loses the entire net premium. If the asset price rises above 1502, the trader starts to make a profit, capped at the difference between the strike prices minus the net premium. The maximum profit is (1550 – 1500) – 2 = 48. The leverage magnifies these outcomes compared to directly buying the underlying asset. For example, imagine the trader had instead directly purchased shares of the index. A £2 increase in the index would have resulted in a £2 profit per share. With the call spread, a £2 increase in the index above the breakeven point leads to a profit, but the initial £2 gain from 1500 to 1502 is only to cover the cost of the spread. The leverage comes from the fact that the maximum potential profit is significantly higher than the initial investment, but so is the potential loss. The CISI Leveraged Trading exam requires a thorough understanding of how leverage affects different trading strategies and how to calculate key metrics like breakeven points. This question tests that understanding in the context of a common options strategy.

The core of this question revolves around understanding how leverage impacts a trader’s margin requirements and potential losses, particularly in the context of fluctuating exchange rates and varying margin percentages. We’ll calculate the initial margin, the impact of the exchange rate change on the position’s value, and then determine if a margin call is triggered. First, calculate the initial margin requirement: 10,000 GBP * 1.25 USD/GBP * 5% = 625 USD. Next, calculate the new value of the position after the exchange rate change: 10,000 GBP * 1.20 USD/GBP = 12,000 USD. The loss on the position is the difference between the initial value and the new value: 12,500 USD – 12,000 USD = 500 USD. Finally, determine if a margin call is triggered. The maintenance margin is typically lower than the initial margin, but for simplicity, let’s assume it’s close to the initial margin. If the account balance falls below the maintenance margin level, a margin call is triggered. In this case, the account started with 625 USD (initial margin). After the loss of 500 USD, the remaining margin is 625 USD – 500 USD = 125 USD. Since 125 USD is significantly below the initial margin of 625 USD (and likely below any reasonable maintenance margin), a margin call is triggered. The scenario highlights the amplified risk of leveraged trading. A relatively small change in the exchange rate (from 1.25 to 1.20) resulted in a substantial loss relative to the initial margin. This demonstrates how leverage magnifies both potential profits and losses. The margin call mechanism is in place to protect the broker from losses, but it also requires the trader to have sufficient funds to cover potential losses. The question specifically tests the understanding of how leverage, exchange rates, and margin requirements interact to determine the outcome of a trade. A key takeaway is that even with a small initial margin percentage, significant losses can quickly erode the account balance, leading to a margin call. It also underscores the importance of monitoring positions closely and having a risk management strategy in place.

Let’s analyze the impact of operational leverage on a hypothetical UK-based manufacturing firm, “Britannia Bolts,” considering both its fixed and variable costs. Operational leverage reflects the sensitivity of a company’s operating income (EBIT) to changes in sales. A high degree of operational leverage implies that a small change in sales can result in a larger change in EBIT due to a higher proportion of fixed costs. The Degree of Operating Leverage (DOL) is calculated as: \[DOL = \frac{\% \text{ Change in EBIT}}{\% \text{ Change in Sales}} \] Or, more practically: \[DOL = \frac{\text{Contribution Margin}}{\text{Operating Income}} \] Where Contribution Margin = Sales – Variable Costs, and Operating Income = Contribution Margin – Fixed Costs. Consider Britannia Bolts. In Year 1, they had sales of £5,000,000, variable costs of £2,000,000, and fixed costs of £2,000,000. Therefore, their contribution margin was £3,000,000 and their operating income was £1,000,000. DOL = £3,000,000/£1,000,000 = 3. Now, imagine Britannia Bolts invests in new automated machinery, increasing their fixed costs to £2,500,000 but reducing their variable costs to £1,500,000. Sales remain at £5,000,000. The contribution margin becomes £3,500,000 and operating income becomes £1,000,000. DOL = £3,500,000/£1,000,000 = 3.5. Now, let’s consider a 10% increase in sales to £5,500,000 in both scenarios. Scenario 1 (Original): Variable costs increase to £2,200,000. Contribution Margin = £3,300,000. Operating Income = £1,300,000. Percentage change in EBIT = ((£1,300,000 – £1,000,000) / £1,000,000) * 100 = 30%. This aligns with the DOL of 3 (10% sales increase * 3 DOL = 30% EBIT increase). Scenario 2 (Automated): Variable costs increase to £1,650,000. Contribution Margin = £3,850,000. Operating Income = £1,350,000. Percentage change in EBIT = ((£1,350,000 – £1,000,000) / £1,000,000) * 100 = 35%. This aligns with the DOL of 3.5 (10% sales increase * 3.5 DOL = 35% EBIT increase). This illustrates how increased fixed costs (and thus higher operational leverage) amplify the impact of sales changes on operating income. Understanding this dynamic is crucial for leveraged trading, as operational leverage can significantly impact a company’s profitability and risk profile, influencing investment decisions.

The question assesses the understanding of how leverage impacts the margin requirements in spread betting, particularly when regulatory changes affect leverage limits. The core concept is that reduced leverage necessitates a higher margin deposit to control the same notional value of the position. Here’s the calculation: 1. **Initial Leverage and Margin:** The initial leverage was 20:1. This means for every £1 of margin, the trader could control £20 of the underlying asset. With a £5,000 margin, the notional value controlled was \( 5000 \times 20 = £100,000 \). 2. **New Leverage and Margin Calculation:** The leverage is reduced to 10:1. To control the same £100,000 notional value, the required margin is now \( \frac{100,000}{10} = £10,000 \). 3. **Additional Margin Required:** The trader needs an additional margin of \( 10,000 – 5,000 = £5,000 \). Now, let’s delve into the rationale behind the calculations and the implications for spread betting. Leverage, in the context of spread betting, is a double-edged sword. It amplifies both potential profits and potential losses. A higher leverage ratio allows a trader to control a larger position with a smaller initial investment, but it also increases the risk exposure. Think of it as using a seesaw; the fulcrum represents your margin, and the weight on either side represents the potential profit or loss. The further you are from the fulcrum (higher leverage), the more dramatic the movement (profit/loss). Regulatory bodies, like the FCA in the UK, often impose leverage limits to protect retail investors from excessive risk. Reducing leverage limits means traders need to deposit more margin to maintain the same level of exposure. This is because the broker needs to ensure they are adequately covered against potential losses. Imagine a car loan: a smaller down payment (lower margin) means higher monthly payments (higher risk for the lender). Similarly, a lower margin in spread betting increases the broker’s risk. In this scenario, the reduction in leverage from 20:1 to 10:1 effectively doubles the margin requirement. This highlights the inverse relationship between leverage and margin. Traders must understand this relationship to manage their risk effectively and avoid margin calls. A margin call occurs when the trader’s account equity falls below the required margin, forcing the broker to close the position to limit their losses. Therefore, the trader needs to deposit an additional £5,000 to maintain their position under the new regulatory regime.

The core of this question revolves around understanding how leverage magnifies both potential gains and losses, and how margin requirements and maintenance margins act as safeguards against these amplified risks. The scenario presents a complex situation where the trader initially benefits from leverage but then faces a market downturn, requiring a margin call. The calculation involves determining the initial equity, the impact of the loss on that equity, and whether the remaining equity falls below the maintenance margin requirement. First, calculate the initial margin: 25% of £200,000 is £50,000. This is the trader’s initial equity. Next, calculate the loss: 10% of £200,000 is £20,000. Subtract the loss from the initial equity: £50,000 – £20,000 = £30,000. Calculate the maintenance margin requirement: 15% of £200,000 is £30,000. Compare the remaining equity (£30,000) to the maintenance margin (£30,000). In this case, the remaining equity equals the maintenance margin. Therefore, no margin call is triggered. A margin call only occurs when the equity falls *below* the maintenance margin. A crucial understanding is that leverage amplifies both profits and losses. The initial leverage allowed the trader to control a larger position with less capital, but the subsequent market downturn rapidly eroded their equity. The maintenance margin acts as a safety net for the broker, ensuring that the trader has sufficient funds to cover potential losses. If the equity falls below this level, the broker issues a margin call to replenish the account. It’s also essential to understand that the leverage ratio (in this case, 4:1) doesn’t directly determine whether a margin call will occur; rather, it’s the combination of the leverage, the initial margin, the maintenance margin, and the magnitude of the losses that dictates the outcome.

The question assesses the understanding of leverage ratios and their impact on investment decisions, particularly within the context of a UK-based trading firm subject to FCA regulations. It requires the candidate to calculate the financial leverage ratio and then analyze how changes in this ratio, due to specific corporate actions (share buybacks), affect the firm’s risk profile and regulatory compliance. First, calculate the initial financial leverage ratio: Financial Leverage Ratio = Total Assets / Shareholder Equity Initial Ratio = £250,000,000 / £50,000,000 = 5 Next, determine the new shareholder equity after the share buyback: New Shareholder Equity = Initial Shareholder Equity – Value of Shares Repurchased New Shareholder Equity = £50,000,000 – £10,000,000 = £40,000,000 Then, calculate the new financial leverage ratio: New Ratio = Total Assets / New Shareholder Equity New Ratio = £250,000,000 / £40,000,000 = 6.25 Finally, analyze the impact. An increase in the financial leverage ratio from 5 to 6.25 indicates that the firm is now using more debt relative to equity to finance its assets. This amplifies both potential profits and potential losses. From a regulatory standpoint, specifically under FCA guidelines, exceeding a pre-defined leverage threshold (hypothetically set at 6 in this case) triggers increased scrutiny and may necessitate the firm to hold more capital reserves to mitigate the elevated risk. The firm might also face restrictions on further leveraged trading activities until the ratio is brought back within acceptable limits. This example highlights how seemingly simple corporate actions can have significant regulatory implications for leveraged trading firms.

To determine the impact of a change in the asset’s value on the leverage ratio, we need to first understand how the leverage ratio is calculated. A common leverage ratio in this context is the Debt-to-Equity ratio, which is calculated as Total Debt / Shareholder’s Equity. Shareholder’s Equity is also equivalent to Total Assets – Total Debt. Therefore, the Debt-to-Equity ratio can also be expressed as Total Debt / (Total Assets – Total Debt). In this scenario, the initial Debt-to-Equity ratio is calculated as £5,000,000 / (£10,000,000 – £5,000,000) = £5,000,000 / £5,000,000 = 1. When the asset value increases by 10%, the new asset value becomes £10,000,000 * 1.10 = £11,000,000. The debt remains constant at £5,000,000. The new Shareholder’s Equity is £11,000,000 – £5,000,000 = £6,000,000. The new Debt-to-Equity ratio is £5,000,000 / £6,000,000 = 0.8333. The percentage change in the leverage ratio is calculated as ((New Ratio – Old Ratio) / Old Ratio) * 100. Therefore, ((0.8333 – 1) / 1) * 100 = -16.67%. This means the leverage ratio decreased by approximately 16.67%. Let’s consider a different scenario to illustrate the concept of leverage. Imagine two identical businesses, “Leveraged Logistics” and “Equity Express.” Both need £1,000,000 to expand. Leveraged Logistics borrows £800,000 and invests £200,000 of its own capital. Equity Express, on the other hand, finances the entire expansion with £1,000,000 of its own capital. If both businesses generate a profit of £150,000 from the expansion, Leveraged Logistics’ return on equity is (£150,000 – interest on £800,000) / £200,000, while Equity Express’ return on equity is £150,000 / £1,000,000. Assuming an interest rate of 5% on the borrowed funds, Leveraged Logistics’ return on equity becomes (£150,000 – £40,000) / £200,000 = 55%, while Equity Express’ return on equity is 15%. This demonstrates how leverage can amplify returns, but it also amplifies losses if the expansion is not profitable.

The question assesses the understanding of how leverage impacts the margin requirements in spread betting, particularly when the initial margin is expressed as a percentage of the underlying asset’s value, and how regulatory changes affect these requirements. The calculation involves determining the initial margin before and after the regulatory change, then comparing them to see the percentage increase. First, calculate the initial margin before the regulatory change: Initial margin before = Underlying asset value * Initial margin percentage Initial margin before = £45,000 * 5% = £2,250 Next, calculate the initial margin after the regulatory change: Initial margin after = Underlying asset value * New margin percentage Initial margin after = £45,000 * 10% = £4,500 Then, calculate the increase in initial margin: Increase in initial margin = Initial margin after – Initial margin before Increase in initial margin = £4,500 – £2,250 = £2,250 Finally, calculate the percentage increase in initial margin: Percentage increase = (Increase in initial margin / Initial margin before) * 100 Percentage increase = (£2,250 / £2,250) * 100 = 100% Therefore, the initial margin requirement increased by 100%. The scenario highlights the direct relationship between regulatory margin requirements and the capital needed to initiate a leveraged trade. For instance, imagine a spread bettor, Anya, who frequently trades FTSE 100 futures. Before the regulatory change, she could open a position with a relatively small margin, freeing up capital for other investments. However, after the margin requirement doubled, she needed to allocate significantly more capital to maintain the same position size. This reduced her trading flexibility and potentially impacted her overall investment strategy. The question also underscores the importance of staying informed about regulatory changes, as these can have a substantial impact on trading costs and profitability. Furthermore, it demonstrates how leverage, while magnifying potential gains, also magnifies the impact of increased margin requirements, making risk management even more crucial. A failure to understand these impacts can lead to unexpected margin calls and potential losses.

The core concept here is understanding how leverage magnifies both gains and losses, and how margin requirements function to mitigate risk for the broker. We need to calculate the initial margin required, the point at which a margin call is triggered, and the investor’s equity at that point. First, we calculate the initial margin required: 25% of £200,000 is £50,000. This is the investor’s initial equity. Next, we determine the price decline that triggers a margin call. The maintenance margin is 20% of the outstanding position. This means the investor’s equity can fall to 20% of £200,000, which is £40,000. The difference between the initial equity (£50,000) and the maintenance margin (£40,000) is £10,000. This represents the maximum loss the investor can sustain before a margin call. To find the percentage decline that causes this £10,000 loss, we divide the allowable loss (£10,000) by the initial position value (£200,000): £10,000 / £200,000 = 0.05, or 5%. Therefore, a 5% decline in the share price will trigger a margin call. At this point, the investor’s equity is at the maintenance margin level of £40,000. The final answer is a 5% price decline, resulting in an equity of £40,000. Consider this analogy: Imagine leverage is like a seesaw. The fulcrum represents your initial investment (margin), and the planks on either side represent potential gains and losses. The further out you go on the plank (higher leverage), the greater the potential movement (gain or loss) with even a small shift in the balance. The margin call is like a safety net placed at a certain distance from the fulcrum. If the seesaw tips too far, the safety net engages, requiring you to add more weight (margin) to prevent a complete imbalance (broker loss). The maintenance margin is the height at which this safety net is placed. A higher maintenance margin means the safety net is closer to the fulcrum, requiring less movement to trigger it.

The question revolves around the concept of leverage and its impact on margin requirements in leveraged trading, specifically within the context of UK regulations and CISI best practices. The scenario involves a trader using a spread betting account to trade FTSE 100 index futures, introducing complexity with varying margin requirements and potential losses. The initial margin requirement is calculated as 5% of the initial position value: \(0.05 \times £750,000 = £37,500\). The trader then experiences a loss of £50,000. The maintenance margin is 75% of the initial margin: \(0.75 \times £37,500 = £28,125\). The trader’s equity after the loss is the initial margin minus the loss: \(£37,500 – £50,000 = -£12,500\). The margin call is triggered when the equity falls below the maintenance margin. The additional funds required to meet the initial margin requirement are calculated as the difference between the initial margin and the current equity: \(£37,500 – (-£12,500) = £50,000\). This calculation illustrates the effect of leverage: a relatively small initial margin controls a large position, and losses are magnified. UK regulations, as interpreted through CISI guidelines, require firms to manage margin calls promptly to protect both the firm and the client from excessive risk. The example demonstrates how a trader can quickly fall into a margin call situation even with a seemingly large initial margin if the market moves against their position. Understanding these mechanics is critical for leveraged trading professionals. The calculation ensures the trader replenishes their account back to the initial margin level, preventing further losses exceeding the initial investment.

The question assesses the understanding of how leverage impacts the required rate of return on equity in a geared investment scenario, considering the cost of debt. The Modigliani-Miller theorem, in a world with taxes, suggests that leverage can increase the value of a firm (and thus potentially reduce the required return on equity) due to the tax shield on debt. However, this is a simplified view. In reality, increased leverage also increases the financial risk to equity holders, demanding a higher rate of return to compensate for this risk. The formula to calculate the required rate of return on equity in a leveraged situation, derived from the cost of capital principles, is: \(r_e = r_0 + (r_0 – r_d) * (D/E) * (1 – T)\) Where: \(r_e\) = Required rate of return on equity \(r_0\) = Cost of capital for an unleveraged firm (12% in this case) \(r_d\) = Cost of debt (7% in this case) \(D/E\) = Debt-to-equity ratio (50%/50% = 1 in this case) \(T\) = Corporate tax rate (20% in this case) Plugging in the values: \(r_e = 0.12 + (0.12 – 0.07) * (1) * (1 – 0.20)\) \(r_e = 0.12 + (0.05) * (1) * (0.80)\) \(r_e = 0.12 + 0.04\) \(r_e = 0.16\) or 16% Therefore, the required rate of return on equity is 16%. This reflects the increased risk equity holders bear due to the company’s leverage. A higher required rate of return is demanded to compensate for the increased volatility and potential for losses associated with a leveraged investment. The tax shield provides some offset, but the overall effect is an increase in the required return. Consider two identical lemonade stands. One is financed entirely by the owner’s savings. The other takes out a loan. The owner of the leveraged stand faces higher fixed costs (loan payments). While the interest payments are tax-deductible, if sales are lower than expected, the leveraged stand is at a much higher risk of failing, thus equity investors would require a higher return to compensate for this risk. This is analogous to the scenario in the question.

Let’s break down how to calculate the required margin and the leverage ratio in this scenario, and then delve into the regulatory implications. First, we need to determine the initial margin requirement. The client is purchasing £200,000 worth of shares using a margin account. The broker requires a 25% initial margin. This means the client must deposit 25% of £200,000 into their account. This is calculated as \(0.25 \times £200,000 = £50,000\). Next, we calculate the leverage ratio. The leverage ratio is the total value of the asset purchased divided by the client’s own equity (the initial margin). In this case, the total value is £200,000 and the equity is £50,000. The leverage ratio is therefore \(\frac{£200,000}{£50,000} = 4\). This means the client has a leverage ratio of 4:1. Now, let’s consider the regulatory implications under UK financial regulations and CISI guidelines. The FCA (Financial Conduct Authority) closely monitors leverage offered to retail clients. While there isn’t a fixed maximum leverage ratio applicable to all share trading, firms must adhere to principles of responsible lending and ensure clients understand the risks involved. High leverage amplifies both potential gains and potential losses. A 4:1 leverage ratio, while not the absolute highest available, is still considered significant and requires the brokerage to provide adequate risk warnings and ensure the client is suitable for such leveraged trading. The CISI emphasizes ethical conduct and suitability assessments. A CISI member advising on or facilitating such a trade must be certain the client understands margin calls, interest charges on borrowed funds, and the potential for losses exceeding their initial investment. The firm’s compliance department would likely review the trade to ensure adherence to internal policies and regulatory requirements. If the client’s account value falls below the maintenance margin (which is typically lower than the initial margin), the broker can issue a margin call, requiring the client to deposit additional funds or face liquidation of their position. Failure to meet a margin call can result in forced selling of the shares, potentially at a loss. This is a key risk that needs to be clearly communicated.

The core of this question revolves around calculating the maximum potential loss, the margin requirement, and the leverage ratio in a complex leveraged trading scenario involving a Contract for Difference (CFD) on a volatile stock. The calculation must consider the initial margin, the stop-loss order, and the price fluctuation of the underlying asset. First, we determine the potential loss per share. The trader buys at £12.50 and sets a stop-loss at £11.00, resulting in a potential loss of £1.50 per share (£12.50 – £11.00 = £1.50). With 2,000 shares, the total potential loss is £3,000 (2,000 shares * £1.50/share = £3,000). Next, we calculate the initial margin requirement. The broker requires a 20% margin on the total value of the position. The total value of the position is £25,000 (2,000 shares * £12.50/share = £25,000). Therefore, the initial margin is £5,000 (20% of £25,000 = £5,000). The leverage ratio is calculated by dividing the total value of the position by the initial margin. In this case, the leverage ratio is 5:1 (£25,000 / £5,000 = 5). Therefore, the maximum potential loss is £3,000, the margin requirement is £5,000, and the leverage ratio is 5:1. This highlights the amplified risk and reward profile of leveraged trading, where a relatively small margin controls a significantly larger position, thereby magnifying both potential gains and losses. Understanding these relationships is crucial for effective risk management and informed decision-making in leveraged trading environments. The stop-loss order mitigates potential losses but doesn’t eliminate them entirely, especially considering potential slippage in volatile market conditions.

Let’s consider a scenario where a fund manager, Amelia, is evaluating two potential leveraged trading strategies using Contracts for Difference (CFDs) on FTSE 100 index. Strategy A involves a higher initial margin requirement but offers a lower commission rate, while Strategy B has a lower initial margin but higher commission. To determine the most suitable strategy, Amelia needs to consider the impact of leverage on both potential profits and losses, as well as the cost of trading (commissions) and the financing costs associated with the leveraged position. First, we need to calculate the total cost of each strategy, including commissions and financing costs. Then, we will assess the potential profit or loss based on a specific market movement and factor in the leverage applied. Finally, we will compare the net profit or loss of each strategy to determine which one provides the best outcome, considering Amelia’s risk tolerance and investment objectives. Here’s how we can approach the calculation: 1. **Calculate the total commission cost for each strategy:** Multiply the number of trades by the commission rate per trade. 2. **Calculate the financing cost for each strategy:** Multiply the leveraged amount by the financing rate and the holding period. 3. **Calculate the total cost:** Sum the commission cost and financing cost. 4. **Calculate the potential profit or loss:** Multiply the change in the FTSE 100 index by the contract size and the number of contracts. 5. **Calculate the net profit or loss:** Subtract the total cost from the potential profit or loss. 6. **Compare the net profit or loss:** Determine which strategy yields the higher net profit or loss. Let’s say Amelia is considering trading 10 CFD contracts on the FTSE 100, with each contract representing £10 per index point. The initial index value is 7500. Strategy A requires a 5% initial margin and charges £5 commission per contract. Strategy B requires a 2% initial margin and charges £10 commission per contract. The financing rate for both strategies is 3% per annum, and Amelia plans to hold the position for 30 days. The FTSE 100 index increases by 100 points during the holding period. **Strategy A:** * Initial Margin: 5% \* (7500 \* £10 \* 10 contracts) = £37,500 * Commission: £5 \* 10 contracts = £50 * Financing Cost: 3% \* (7500 \* £10 \* 10 contracts – £37,500) \* (30/365) = £438.36 * Total Cost: £50 + £438.36 = £488.36 * Profit: 100 points \* £10 \* 10 contracts = £10,000 * Net Profit: £10,000 – £488.36 = £9,511.64 **Strategy B:** * Initial Margin: 2% \* (7500 \* £10 \* 10 contracts) = £15,000 * Commission: £10 \* 10 contracts = £100 * Financing Cost: 3% \* (7500 \* £10 \* 10 contracts – £15,000) \* (30/365) = £1,767.12 * Total Cost: £100 + £1,767.12 = £1,867.12 * Profit: 100 points \* £10 \* 10 contracts = £10,000 * Net Profit: £10,000 – £1,867.12 = £8,132.88 In this scenario, Strategy A yields a higher net profit (£9,511.64) compared to Strategy B (£8,132.88). This highlights the importance of considering all costs associated with leveraged trading, including commissions and financing, when evaluating different strategies. While Strategy B has a lower initial margin requirement, the higher commission and financing costs outweigh this benefit, resulting in a lower overall profit. Amelia should also consider the impact of a potential loss, where Strategy B’s lower initial margin might provide more flexibility, but the higher costs would still reduce the overall outcome.

Let’s break down how to calculate the effective leverage ratio in this scenario. The key is to understand that the margin requirement acts as a buffer, reducing the overall leverage. The initial margin available is the starting point, and the profit generated increases the available margin, thereby impacting the effective leverage. First, calculate the total initial margin available: £50,000. The initial margin is 20%, meaning the total position value the trader can control is calculated as follows: Total position value = Initial Margin / Margin Requirement = £50,000 / 0.20 = £250,000 Next, consider the profit made on the trade: £25,000. This profit increases the available margin. The new available margin is: New Available Margin = Initial Margin + Profit = £50,000 + £25,000 = £75,000 Now, we calculate the new total position value that *could* be controlled with this increased margin, still maintaining the 20% margin requirement: New Potential Position Value = New Available Margin / Margin Requirement = £75,000 / 0.20 = £375,000 The effective leverage ratio is calculated by dividing the total position value by the available margin. Since the trader didn’t increase their position size, we use the initial position size of £250,000 and the *new* available margin of £75,000: Effective Leverage Ratio = Total Position Value / New Available Margin = £250,000 / £75,000 = 3.33 Therefore, the effective leverage ratio is 3.33:1. The crucial element here is understanding that profit increases the margin available, effectively *reducing* the leverage being used. The trader *could* increase their position size with the increased margin, but they haven’t. This highlights the dynamic nature of leverage and how it’s affected by trading outcomes. A higher profit leads to a lower effective leverage ratio, assuming the position size remains constant. This is different from the *potential* leverage, which would be calculated based on the new available margin and the margin requirement, as shown in the calculation of New Potential Position Value.