> If you have $110 million in assets and $100 million in liabilities you are said to be levered 10:1
There is no single leverage ratio [1]. On an asset basis, this is an 11:1 leverage ratio, i.e. $11 of assets for each dollar of equity. A lot of miscommunication around leverage seems to stem from this ambiguity.
Yes, it seems he even mixed definitions as well. He said that the $110M in assets and $100M in liabilities was a 10:1 leverage.
However, later he says that a home owner with a down payment of 20% is levered 5:1. Yet, if we do the same math as he did above, then 20% of $100,000 loan is $20k in equity with an $80k loan, giving a leverage ratio of 4:1.
I came to the comments to check if that was correct - I was following that definition and calculated 4:1 in my head, too.
Later he uses the example of purchasing $2000 worth of ($10) stock by paying just $1000 and having the other thousand lent by the brokerage.
As per his definition, $2000 in stocks (assets) minus the $1000 loan (liability) equals $1000 in equity. Then if leverage = equity/liability, in this case it turns out to be 1:1
Where does the ratio of 10 to 1 come in here? I see 110:100, or 1.1:1, or 10%.
His explanation doesn't make sense to me. Are those assets borrowed or something? And having $10 million extra in assets means that if suddenly all your liabilities come due, you have $10m left over? How could that possibly wipe you out?
> the example as given seems to be $1.10 of equity (assets)
Equity (in accounting) is assets minus liabilities. $110mm assets, $100mm liabilities and thus $10mm equity.
You may be thinking of equities (from trading), which is another word for stock. (The link being equities represent ownership of equity, i.e. the value of a company’s assets net of liabilities.)
I think I'm having a slow moment... why are we more interested in the ratio of equity to liability, than the ratio of assets to liabilities?
It seems to me that if bad things happen, you can cover for the value of your liabilities with your assets. You could waste the entire excess equity on banana monkey NFTs and still be solvent, assuming no liquidity issues.
That ratio tells you how much faster you make or lose money under an asset price movement. That is, if you’re 11:1 leveraged, a 0.01% increase in asset price is a 0.11% increase in your net equity.
the key that they seem to delight in not telling you is that the 100M debt also came with 100M in assets - you borrowed 100M cash (an asset you now have) and promise to give it back later (a liability you now also have). Apart from those offsetting 100M entries on your books, you also have 10M other assets.
so you may have started with 10M - then you borrowed (and promise to repay) 100M more. there's your 1:10 (10:100) ratio.
There is no single leverage ratio [1]. On an asset basis, this is an 11:1 leverage ratio, i.e. $11 of assets for each dollar of equity. A lot of miscommunication around leverage seems to stem from this ambiguity.
[1] https://corporatefinanceinstitute.com/resources/accounting/l...