Leverage

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The use of borrowed funds along with owned funds for investment is called leverage. The ratio of borrowed funds to own funds (or debt to equity) is called the leverage ratio.[1] Leverage involves the use of various financial instruments, including options and futures.

Leverage also refers to the amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. Companies use debt to finance their operations. This increases their leverage because it enables them to invest in business operations without increasing equity.

Portfolios, however, become riskier with leverage. With too much leverage, a market downturn can wipe out all of the equity and leave the investor with more debt than assets.[2]

References

  1. Capital Leverage: Financial Intermediation. San Jose State University Economics Department.
  2. Living With Leverage. Forbes.com.