The Role of Leverage in STIR's Risk Procedure


Leverage and Risk

Leverage and risk are different-but frequently conflated-concepts. Risk is concerned with the liklihood of the value of a balance sheet's assets declining by a certain amount. Leverage, on the other hand, measures the decline of the value of an equity stake given a decline in the value of assets.
From a risk management perspective, leverage is an important property of a fund because the extent to which the fund's portfolio is leveraged is a good proxy for the likelihood of an involuntary liquidation of positions. Such forced de-leveraging destroys value in the fund's balance sheet and is something a prudent manager works to ensure never happens.

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