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Mat 540 Week 1

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Question 1 Example 1 (Unleveraged ETF) Assume that P = $1000, r = 10% (0.1), k = 365, t = 1, F = 〖P(1+ r/k )〗^kt = 〖1000(1+ 0.1/365 )〗^365x1 = $1105.16 Return = $1105.16 - $1000 = $105.16 (Triple-leveraged ETF) Assume that P = $1000, r = 30% (0.3), k = 365, t = 1, F = 〖P(1+ r/k )〗^kt = 〖1000(1+ 0.3/365 )〗^365x1 = $1349.69 Return = $1349.69 - $1000 = $349.69 Ratio = 349.69/105.16 = 3.33 Therefore, triple-leveraged ETF gives higher return than the unleveraged ETF. The return is not exactly three times, it is slightly more than three times of the return. Example 2 (Unleveraged ETF) Assume that P = $1000, r = -2% (-0.02), k = 365, t = 1, F = 〖P(1+ r/k )〗^kt = 〖1000(1+ (-0.02)/365 )〗^365x1 = $980.20 …show more content…

The loss is not exactly three times but slightly less than three times of the loss from the unleveraged ETF. Investors tend to use triple-leveraged ETF to obtain triple the return yield of the investments. However, they are discouraged to invest on triple-leveraged ETF as the disadvantages overwhelm the advantages. One of the advantages of triple-leveraged ETF is that it gives three times the return whereas one of the disadvantages of triple-leveraged ETF is that it could lose triple of the tracked index. According to Cummans (2015), ‘The additional risks come in the form of counterparty risk, liquidity risk, and increased correlation risk’. Thus, ETF has higher risk as it may lose three times the return and increases bankruptcy rate. Result shows that the annual return to the triple-leveraged ETF is expected to be triple the annual return to the S&P 500 index, it is only applicable to theory where everything is in constant. In reality the tracked index fluctuating frequently, it will not be three times of the

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