If the use of leverage is ________, the performance presented must include the effects of the leverage.
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A. B. C. D.Explanation
If the use of leverage is nondiscretionary (i.e. mandated by the client), performance must be presented on an all-cash basis.
The correct answer is C. discretionary.
When it comes to the use of leverage, it can be categorized into three main types: mandatory, nondiscretionary, and discretionary. In this case, the question specifically asks about the performance that must include the effects of leverage, indicating that the use of leverage is discretionary.
To understand the implications of discretionary leverage, let's define each type of leverage:
Mandatory leverage: This type of leverage refers to situations where the use of leverage is required or mandated. For example, certain investment funds or financial institutions may be obligated by regulations or investment guidelines to use leverage. In such cases, the performance calculations must include the effects of leverage, as it is mandatory.
Nondiscretionary leverage: Nondiscretionary leverage is a type of leverage that is not mandatory but is used consistently. In other words, it is not required by regulations or guidelines, but once it is implemented, it is used on a regular basis. In this case, the performance calculations may or may not include the effects of leverage, depending on the specific circumstances or reporting requirements.
Discretionary leverage: Discretionary leverage refers to the use of leverage that is optional and subject to the decision-making authority of the manager or investor. This means that the decision to use leverage is made at the discretion of the manager or investor based on their judgment and investment strategy. In this case, if leverage is utilized, the performance presented must include the effects of the leverage. Therefore, the answer to the question is C. discretionary.
In summary, when leverage is discretionary, the performance presented must include the effects of leverage. This implies that the manager or investor has the option to use leverage, and if they choose to do so, the performance calculation should reflect the impact of leverage on the investment returns.