Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which ratio is referred to as a leverage ratio?

1. Current Ratio

2. Solvency Ratio

3. Defensive Interval Ratio

4. Liquidity Ratio

The correct answer is: Solvency Ratio

The solvency ratio is a measure of a company's ability to meet its long-term obligations, making it a key indicator of financial leverage. This ratio assesses the relationship between a company's total assets and total liabilities, providing insights into how much of the company's assets are financed through debt. A higher solvency ratio indicates that a company is more solvent and less reliant on leverage; conversely, a lower ratio may signal that the company is using a higher level of debt relative to its assets. This characteristic of incorporating both liabilities and assets establishes it as a leverage ratio, highlighting the extent to which a company is leveraging its assets to finance its operations. In contrast, the current ratio focuses on short-term liquidity, the defensive interval ratio assesses the duration a company can sustain its operations without additional cash inflows, and liquidity ratios evaluate a company's ability to cover short-term obligations. These ratios do not specifically analyze the balance between debt and assets in the context of long-term financial stability, which is central to the definition of a leverage ratio.