Why leverage is not used in a private exchange fund?

The last sentence on page 339 and the first sentence on page 340, curriculum vol 2 says the private exchange fund“ will create the opportunity to borrow against the stock at more advantageous terms than would be the case if it were not hedged, and without creating the additional risks associated with leverage ”. Sounds like leverage is NOT used, which is also confirmed by the answer to Q2 in morning session of 2007 exam.

But in the second paragraph on page 340, it says that “the partners in a private exchange fund have the ability to choose, and vary over time, the investment bought with the proceeds of the borrowing”. Is the “choose investment” meant by making investment beyond the portfolio(eg., an investor make a personal investments by himself) rather than in the portfolio?

In other words, is there any difference between leverage and borrowing against the securities in the portfolio? Tks

Actually, I had this same question. I did not understand how the terminology “the fund partners with other investors who buy the illiquid security in the market,they then hedge, borrows and re-invest” does not qualify as leverage.

I also don’t understand how a collar is not leverage, as I have seen multiple references in the text to any option or derivative strategy having implicit leverage just by the nature of their payoff.

I think the difference is the ability to borrow against the pool of securities in your personal account without the private exchange fund itself levering up. Therefore the fund remains unlevered, but you could personally lever up against your holding in it.

Collar is not leverage at all. It basically takes an existing holding and puts a floor and a ceiling on it (collared).

I am a little confused by “pool of securities” . somehow I had the impression that a private exchange fund brought together investors who all owned the same security . The fact that they wer able to put together much larger asset size than any single investor gave the group leverage since they were able to go to a bank or institution , offer the block as a loan in exchange for collateral which they could then invest as a diversification step . Since the stock was collateralized , the leverage , if you can call it that , was low . Also there is some kind of law in the US requiring one of the investors to be unrelated

They borrow against the stock, which is leverage, period. I don’t understand how they say it’s not, if you have a debt component in a capital structure, you are leveraged.

Options are leverage by nature, are they not, prophets? The payoff is assymetrical. I suppose the collar as a whole may be an exception because of the nature of the payoff diagram.

options by definition are actually a form of insurance. your exposure obviously depends on whether or not you are a buyer or a seller.

it can technically create leverage. for example. if i buy 100,000 shares of ORCL that wil cost me $2,938,000. Or I can go to the JAN 2013 ORCL calls and buy 1000 call contracts w/ a strike of $20. They are $9.38 in the money and they cost me $9.60 each. They are deep in the money calls. I only have to pay $960,000 and I have notional control of the same number of shares. So yea, it can create leverage. But that doesn’t mean all options contracts are “leverage”.

if you are already long 100,000 shares of ORCL and you sold 1000 calls strike JAN 2013 at $32 for $1.50 each are you creating leverage or effectively hedging your position? you’ve hedged.

options are whatever you want to make of the position. strangles, straddles, butterfly spreads. there are dozens of different position types. they don’t necessary create leverage. it’s a hedging/insurance tool that pays off when above a strike price.