Personal Finance

Who is in a riskier financial position?

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Banned
Jan 11, 2004
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techcrium wrote: Let's assume B is renting a place for $550 a month

A home's is a condo.

But your questions shouldn't be really relevant unless you think you can predict real estate growth/crashes on location. That in itself is a prediction. I'll leave real estate predictions for the other thread.
of course you can predict RE price appreciation on location..real estate is all about location....

but with your example..option A is way better off... a $340k condo will be multiple times better than a $550 a month dump..there is no option here..it's like what's better..eating garbage from trash can for free or paying $20 to eat a proper meal
Penalty Box
Apr 16, 2012
3565 posts
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Greely
gilboman wrote: of course you can predict RE price appreciation on location..real estate is all about location....

but with your example..option A is way better off... a $340k condo will be multiple times better than a $550 a month dump..there is no option here..it's like what's better..eating garbage from trash can for free or paying $20 to eat a proper meal
Of course A is way better off. But my question was not whether a person was better off.

My question was whether a person is riskier.
Deal Fanatic
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Dec 14, 2010
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techcrium wrote: For once, there is no hidden agenda here. Just want some opinions between the 2 parties.

Person A:
Asset: $340,000 in home
Liability: $270,000 mortgage remaining @ 2.3%

Income $60,000 per year


Person B:
Assets: $200,000 in equities (etfs, individual equities, etc)
Liabilities: LOC: $80,000 @ 2.5%; Margin: $20,000 @ 3%

Income: $50,000 per year
Here is how I see it:
A has a networth of $70k. $60k income. 79% leveraged.
B has a networth of $100k. $50k income. 50% leveraged.

A has 100% of bad debt (mortgage).
B has 100% of good debt (borrow to invest, which builds wealth and is tax deductible).

If A's income stop, A cannot pay the mortgage.
If B's income stop, the dividends and tax refund covers the interest, and therefore, the minimum can be paid.

A is in a financially riskier position IMO.

Rod
Banned
Nov 27, 2006
2200 posts
445 upvotes
Toronto
techcrium wrote: For once, there is no hidden agenda here. Just want some opinions between the 2 parties.

Person A:
Asset: $340,000 in home
Liability: $270,000 mortgage remaining @ 2.3%

Income $60,000 per year


Person B:
Assets: $200,000 in equities (etfs, individual equities, etc)
Liabilities: LOC: $80,000 @ 2.5%; Margin: $20,000 @ 3%

Income: $50,000 per year
leverage is BORROWING funds to invest.
a) borrowed 270,000 on 70,000 in equity = 3.8:1
b) borrowed $100,000 on $200,000 = 1:2

For every $1 borrowed, B has $2
For every $3.80 borrowed, A has $1

You got your ratios backwards.

E.g. YOU ARE LEVARAGED ALMOST 4 to 1!!!! that doesn't mean you have 4 times the assets to 1 dollar of borrowwed funds.

guess these forums are cloudying your math skills.
Deal Fanatic
Jul 3, 2011
6517 posts
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Thornhill
sirex wrote: leverage is BORROWING funds to invest.
a) borrowed 270,000 on 70,000 in equity = 3.8:1
b) borrowed $100,000 on $200,000 = 1:2

For every $1 borrowed, B has $2
For every $3.80 borrowed, A has $1

You got your ratios backwards....
Well no. It's possible that B had $200,000 worth of equities and used it to borrow $80,000 on an LOC, but the margin account is not a loan. And if that is the case then the leverage is 1:2.75

Perhaps I misunderstand what Techrium was getting at with his post. But it seems to me he was implying B's equities were purchased on leverage where B’s only cash is $20,000 in his margin account. So he either used $80,000 from his line of credit to purchase what can only be $80,000 worth of investments and used a margin account of $20,000 to borrow $100,000 at 5:1 leverage in which case B’s investments of $200,000 was all on borrowed funds of $180,000.

Or he leveraged his margin account at 9:1 and also borrowed $80,000 which would make his leverage 13:1.

Even if my take on Techrium’s post is not correct you’ve got B’s formula backwards.
Banned
Nov 27, 2006
2200 posts
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Toronto
He should be more clear then. My understanding of his post is simple:

B has $200,000 in equities. Of which we assume $80,000 of those equities were bought using the line of credit and $20,000 of those equities were bought using margin.

That would still be a 1:2 ratio of borrowed funds to current assets.


i highly doubt that OP would make this thread that complex. He is trying to determine which is riskier on a simple model. The answer is that A is less risky from a lending stand point because A has real property and the loan is secured by that. B has floating assets on a floating loan.
Deal Fanatic
Jul 3, 2011
6517 posts
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Thornhill
Still incorrect.

You cannot calculate the ratio using the borrowed $20 and also include in to come to $200k when doing the ratio.

By your take which is that $20k was borrowed to buy $20k of equities then he previously had $180k of unencumbered equities and the correct ratio would be 1:9. Add in the $80,000 heloc and it becomes 5:9.

And if you still don’t understand let’s strip it away to make it easier and say he didn’t have any equities before borrowing $20k. By your arithmetic the ratio would be 20,000:20,000 to get to 1:1 which is wrong.

The point of a margin fund is to use that amount to borrow multiples of same to make the purchase so the $20k is either cash sitting in the margin account or has been used to purchase equities.

You’ve previously stated you’re a mortgage agent so you should know that if you want to assume the $20k is also a loan it has to be treated exactly as you did the mortgage for A.

There's nothing complex about his post. If you read Techrium’s post it is clear to see he is calling B a riskier position because the $200,000 was bought on leverage otherwise it makes no sense to conclude that anyone sitting with assets twice the amount of liabilities is riskier than someone sitting with assets of $70,000 and a loan of $240,000. He just hasn’t expressed it in full and I presume it’s because he’s taken it for granted that the crowd he is addressing understands because they constantly speak of investments in the stock market.
sirex wrote: He should be more clear then. My understanding of his post is simple:

B has $200,000 in equities. Of which we assume $80,000 of those equities were bought using the line of credit and $20,000 of those equities were bought using margin.

That would still be a 1:2 ratio of borrowed funds to current assets.


i highly doubt that OP would make this thread that complex. He is trying to determine which is riskier on a simple model. The answer is that A is less risky from a lending stand point because A has real property and the loan is secured by that. B has floating assets on a floating loan.
Penalty Box
Apr 16, 2012
3565 posts
688 upvotes
Greely
I think my post was pretty clear for B:

Networth: $100,000

Assets: $200,000 worth of equities

Debt: $80,000 Line of Credit Loan; $20,000 margin debt


In your brokerage balance sheet it would show:
stocks: $200,000
cash: -$20,000
total equity: $180,000

Of course the $80,000 is financed from LOC.

Leverage? 2:1
wikipedia wrote: http://en.wikipedia.org/wiki/Leverage_( ... nvestments
Accounting leverage is total assets divided by the total assets minus total liabilities.
What are B's total assets? $200K. What are B's Assets - Liabilities? $100K

What is $200K / $100K ???

2:1


I thought I was speaking amongst renters who are investors here...
Penalty Box
Apr 16, 2012
3565 posts
688 upvotes
Greely
sirex wrote: Guess you don't know what leverage means if you think that B us leveraged 2:1
sirex wrote: NOt sure why you guys feed this troll when he doesn't even know what leverage is
sirex wrote: leverage is BORROWING funds to invest.
a) borrowed 270,000 on 70,000 in equity = 3.8:1
b) borrowed $100,000 on $200,000 = 1:2

For every $1 borrowed, B has $2
For every $3.80 borrowed, A has $1

You got your ratios backwards.

E.g. YOU ARE LEVARAGED ALMOST 4 to 1!!!! that doesn't mean you have 4 times the assets to 1 dollar of borrowwed funds.

guess these forums are cloudying your math skills.
sirex wrote: He should be more clear then. My understanding of his post is simple:

B has $200,000 in equities. Of which we assume $80,000 of those equities were bought using the line of credit and $20,000 of those equities were bought using margin.

That would still be a 1:2 ratio of borrowed funds to current assets.


i highly doubt that OP would make this thread that complex. He is trying to determine which is riskier on a simple model. The answer is that A is less risky from a lending stand point because A has real property and the loan is secured by that. B has floating assets on a floating loan.

http://en.wikipedia.org/wiki/Leverage_( ... nvestments

I encourage you look at wikipedia you noob.

Financial Leverage = Total Assets / Shareholders Equity

Accounting leverage is total assets divided by the total assets minus total liabilities


What are B's assets? $200K

What is B's equity? $100K

What is 200k:100k?

2:1

lol you noob. With you weak mathematics skills and stark arrogance, I would love to see your investment portfolio and how it's faired.
Deal Addict
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Apr 23, 2009
1783 posts
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You initially didn't mention the word 'financial leverage'. You merely said 'leverage' which could mean many things. Technically, the word leverage could be used in any context to describe a multiplier effect (or the inverse). Most common leverage ratio used in investment context is 'Debt/Equity' ratio. Another common leverage ratio is Debt Ratio (i.e. Total Debt / Total Assets). Sometimes it is used in reverse or backward (i.e. inverse). That is how you used it. Total Assets/ Debt or Total Equity / Debt. So both of you are correct.

However, you were vague when you just used the word 'leverage' without explaining what do you mean by it. Most people would just assume you meant debt/equity ratio.
techcrium wrote: http://en.wikipedia.org/wiki/Leverage_( ... nvestments

I encourage you look at wikipedia you noob.

Financial Leverage = Total Assets / Shareholders Equity

Accounting leverage is total assets divided by the total assets minus total liabilities


What are B's assets? $200K

What is B's equity? $100K

What is 200k:100k?

2:1

lol you noob. With you weak mathematics skills and stark arrogance, I would love to see your investment portfolio and how it's faired.
Penalty Box
Apr 16, 2012
3565 posts
688 upvotes
Greely
ruchir wrote: You initially didn't mention the word 'financial leverage'. You merely said 'leverage' which could mean many things. Technically, the word leverage could be used in any context to describe a multiplier effect (or the inverse). Most common leverage ratio used in investment context is 'Debt/Equity' ratio. Another common leverage ratio is Debt Ratio (i.e. Total Debt / Total Assets). Sometimes it is used in reverse or backward (i.e. inverse). That is how you used it. Total Assets/ Debt or Total Equity / Debt. So both of you are correct.

However, you were vague when you just used the word 'leverage' without explaining what do you mean by it. Most people would just assume you meant debt/equity ratio.

When dealing with investing, anytime someone says they are leveraged 5 to 1, it is automatically assumed they are buying 5 times the assets backed by 1 times the equity.

If I wanted to mention debt to equity, I would have said B's debt to equity ratio is 0.5.

It is automatically assumed when a person is leveraged 4:1, it means they are buying a $400,000 house with $100,000 down.

Just like when talking about computers, and someone mentions the word bug, it is automatically assumed they are referring to program error instead of the insect. The person talking shouldn't have to say, "Oh I didn't mean the insect!"
Deal Addict
Sep 6, 2010
2029 posts
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Vancouver
techcrium wrote: http://en.wikipedia.org/wiki/Leverage_( ... nvestments

I encourage you look at wikipedia you noob.

Financial Leverage = Total Assets / Shareholders Equity

Accounting leverage is total assets divided by the total assets minus total liabilities


What are B's assets? $200K

What is B's equity? $100K

What is 200k:100k?

2:1

lol you noob. With you weak mathematics skills and stark arrogance, I would love to see your investment portfolio and how it's faired.
OP back at it again...someone is wound awful tight.
Sr. Member
Jan 12, 2005
908 posts
96 upvotes
houska wrote: About the same overall, but different risk levels to different risks.
I think of this in terms of several plausible downside scenarios. How resilient are A and B to each one. (Assuming A's asset is the house they have a mortgage on)

Scenario 1. Equity market downturn of ~40%, followed by a few years of languishing returns before picking up again. A is not directly affected (though I would expect house prices to also decline a bit). B is nearly wiped out. Both hopefully still have jobs and a bed to sleep in.
Scenario 2. Housing bubble pops, 20% drop in home prices followed by a few years of stagnation. A's equity is wiped out, but they still have a job and a bed to sleep in. B is not directly affected, though I would expect there will also be pressure on equity prices if the housing bubble pop is widespread.
Scenario 3. Job loss. A is in trouble, since likely challenged to keep up on mortgage payments. B can liquidate some investments and take time finding a job.
Scenario 4. Unexpected need to obtain cash (family health emergency, replace car, etc). A will have a harder time than B.
Scenario 5. Temptation/human psychology challenge. A less risky here than B -- enforced financial discipline on A, while B can make stupid lifestyle inflation or investment mismanagement decisions.

So A's frightening risks come from scenario 2,3,4; while B's from 1 and 5.
you win! best answer!
Banned
Nov 27, 2006
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Toronto
techcrium wrote: When dealing with investing, anytime someone says they are leveraged 5 to 1, it is automatically assumed they are buying 5 times the assets backed by 1 times the equity.

If I wanted to mention debt to equity, I would have said B's debt to equity ratio is 0.5.

It is automatically assumed when a person is leveraged 4:1, it means they are buying a $400,000 house with $100,000 down.

Just like when talking about computers, and someone mentions the word bug, it is automatically assumed they are referring to program error instead of the insect. The person talking shouldn't have to say, "Oh I didn't mean the insect!"
Maybe im ***** but you're double counting.

If i have 100,000 and the bank gives me a 400,000 mortgage to buy a 500,000 house my leverage is only
4:1
i get a 500,000 home not a 400,000 home. This means for every dollar i put in i get 4.

In your example of 4:1 you are saying you bought a 400,000 home with 100,000. Your leverage is only 3:1 not 4 to 1 because you don't use the amount of money you have as part of the ratio.

You even said it your self the debt equity ratio is .5

.5 as a ratio is 1:2 not 2:1

In your example of b he has 20,000 and 80,000 worth of debt. 100,000 debt total.

B also has 200,000 of assets of which 100,000 is his. He had only borrowed 100,000.

So i think we are both wrong then and the answer is 1:1 as b is not leveraged.

But in common speak when someone says they are leveraged 2 to 1 that means they have borrowed two dollars for every one of there dollars
Penalty Box
Apr 16, 2012
3565 posts
688 upvotes
Greely
Before you argue with me, perhaps you should read the wikipedia article...
http://en.wikipedia.org/wiki/Leverage_( ... nvestments
Borrow $100 and buy $200 of crude oil. Assets are $200, liabilities are $100 so accounting leverage is 2 to 1. The notional amount is $200 and equity is $100, so notional leverage is 2 to 1. The volatility of the position is twice the volatility of an unlevered position in the same assets, so economic leverage is 2 to 1.
You have $100 in cash and you borrow another $100 to buy $200 of crude oil.

What is your leverage? 2:1

You have $100,000 cash and you borrow $100,000 to buy $200,000 worth of equities.

What is your leverage?

I think the math should be pretty simple.


And lol B is not leveraged? B just borrowed $100,000 to buy equities and B is not leveraged? How does that logic even work? Please explain to me.
Penalty Box
Apr 16, 2012
3565 posts
688 upvotes
Greely
sirex wrote:B also has 200,000 of assets of which 100,000 is his. He had only borrowed 100,000.

So i think we are both wrong then and the answer is 1:1 as b is not leveraged.
Sirex's logic: If you have $100,000 cash and you buy a $200,000 home...you're leverage is 1:1...so therefore you are not leveraged.
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Feb 7, 2008
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sirex wrote: Maybe im ***** but you're double counting.

If i have 100,000 and the bank gives me a 400,000 mortgage to buy a 500,000 house my leverage is only
4:1
i get a 500,000 home not a 400,000 home. This means for every dollar i put in i get 4.

In your example of 4:1 you are saying you bought a 400,000 home with 100,000. Your leverage is only 3:1 not 4 to 1 because you don't use the amount of money you have as part of the ratio.

You even said it your self the debt equity ratio is .5

.5 as a ratio is 1:2 not 2:1

In your example of b he has 20,000 and 80,000 worth of debt. 100,000 debt total.

B also has 200,000 of assets of which 100,000 is his. He had only borrowed 100,000.

So i think we are both wrong then and the answer is 1:1 as b is not leveraged.

But in common speak when someone says they are leveraged 2 to 1 that means they have borrowed two dollars for every one of there dollars
:facepalm:
Banned
Nov 27, 2006
2200 posts
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Toronto
So thats hoe out works. Glad i have rfd to teach me things.

So is b or a worse of then

And what is a,s leverage ratio
Banned
Nov 27, 2006
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techcrium wrote: Sirex's logic: If you have $100,000 cash and you buy a $200,000 home...you're leverage is 1:1...so therefore you are not leveraged.
Yeah exactly almost as logical as this thread that proves nothing except that you're an re bull. .........yawn
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Nov 27, 2006
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gwplant wrote: OP back at it again...someone is wound awful tight.
Stark arrogance said the pot to the kettle.

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