Question says: A portfolio manager has a portfolio worth $100m, $30m of which is his own funds and $70m is borrowed. If return on invested funds is 6% and the cost of borrowed funds is 5%, calculate the return on the portfolio. Gross profit on portfolio= 100m x 6% = 6m Cost of borrowed funds = 70m x 5% = 3.5m Net profit on portfolio = 6m - 3.5m = 2.5m The return on equity invested (i.e. the portfolio) = $2.5m/$30m = 8.33% The question has asked for the return on the portfolio, so why are we dividing by equity (30m), not entire portfolio (100m)? I’m getting confused since other topics (like hedged portfolio return and effective beta) calculate hedged portfolio return as gain on portfolio / beginning portfolio value.
The returns to a leveraged investment are amplified compared to an otherwise identical unleveraged investment.
In this case the $30m of his own funds… Since it is equity invested which is 30% of the portfolio and the rest has been borrowed…