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1) Leverage and risk. This question examines leverage. It is in the context of a personal investment in a home. However, the basic idea applies generally to investments made with borrowed money. (10) With your Masters from the University of Queensland in hand you have decided to purchase an apartment in Spring Hill. The apartment costs $200,000. A) I have calculated the percentage return on the apartment as a function of possible apartment prices next year (2nd row of the table).

Apartment Price (next year) Return

$180K

$190K

$200K

$210K

$220K

$230K

-10%

-5%

0%

5%

10%

15%

Assume you purchase the apartment with cash. This means you don't have to borrow any money to purchase your new home. Graph the one year realised net return on your $200,000 investment as a function of the percentage return on the apartment. Recall that the realised net return is calculated by dividing the payoff from the investment by the initial investment and subtracting one. (2)

50%

30%

10% ROI -10%

-30%

-50% -10% -5% 0% Return on Apt 5% 10%

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B)

Now assume that you only have $100,000 to invest in your new home. Your current shortage of funds has not deterred you from purchasing the $200,000 apartment. You borrow the remaining $100,000 from a bank, promising to repay the loan plus 5% interest in one year. Graph the return on your $100,000 investment as a function of the percentage return on the apartment. Remember to account for the bank’s stake in the investment in both the payoff and in the initial investment. (2)

50%

30%

10% ROI -10%

-30%

-50% -10% -5% 0% Return on Apt 5% 10%

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C) Now assume that you have only $50,000 to invest in your new home. You still want to purchase the same apartment for $200,000, so you borrow $150,000 from the bank. You promise to repay the loan plus 5% interest in one year.