California Real Estate Practice Exam

An investor needed cash for additional investments, and "took out" a loan against his property. His interest payment on this new loan was less than the net return he was realizing on the property. This is an example of:

1. Band of investment

2. Capital turnover

3. Deficit financing

4. Trading on equity

The correct answer is: Band of investment

The scenario described illustrates the concept of trading on equity. In this case, the investor has leveraged the equity in their property to obtain a loan, and the interest expense associated with that loan is lower than the net return generated from the property. This situation indicates that the investor is utilizing borrowed capital to enhance their overall returns on investment. Trading on equity refers to the use of borrowed funds to increase the potential return on investment. By taking out a loan against the property, the investor is effectively using the available equity to pursue additional investment opportunities while still maintaining a positive cash flow from their existing property. The other options do not rightly apply to this scenario. The band of investment concept involves evaluating the total return on property investments and does not specifically address leveraging equity. Capital turnover focuses on the efficiency of using capital to generate revenue rather than the benefits of leveraging equity. Deficit financing typically refers to funding through borrowing to cover operational shortfalls, which isn't the case here as the investor is leveraging for growth, not addressing a deficit. Thus, the correct context and application of the concepts clearly align with trading on equity.