Non-Discretionary Leverage Performance Presentation

B

According to Section B of the PPS standards - "Calculation of Returns" - for non-discretionary leverage, performance must be presented on an all-cash returns basis.

Non-discretionary leverage refers to the use of borrowed funds by a firm without any flexibility or discretion in determining the amount of leverage employed. In other words, it is a fixed or predetermined level of leverage that is used consistently by the firm.

When a firm uses non-discretionary leverage, it must present performance using the all-cash basis, which is the answer B. The all-cash basis presentation removes the effects of leverage from the performance figures.

Here's a detailed explanation:

Leverage involves using borrowed funds, such as debt, to finance investments or operations. It can amplify returns when investments perform well, but it can also magnify losses if investments decline in value. When a firm uses discretionary leverage, it has the flexibility to adjust the level of leverage based on market conditions or other factors. However, with non-discretionary leverage, the firm is bound to a fixed or predetermined level of leverage that it uses consistently.

To evaluate the performance of a firm using non-discretionary leverage, it is important to remove the effects of leverage from the performance figures. This is because leverage can distort the actual returns generated by the firm. By presenting performance on an all-cash basis, the leverage effects are eliminated, providing a more accurate representation of the firm's underlying performance.

The all-cash basis presentation adjusts the performance figures by removing the impact of interest expense related to the borrowed funds. It treats the investments as if they were made with the firm's own cash, disregarding the borrowed funds. This allows for a fair comparison of the firm's performance with other investment opportunities or benchmarks.

In summary, when a firm uses non-discretionary leverage, it must present performance using the all-cash basis, which removes the leverage effects and provides a more accurate assessment of the firm's actual returns. Therefore, the correct answer to the question is B. all-cash basis i.e. removing leverage effects.