Difference between revisions of "Leverage"

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Leverage is the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.
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The use of [[borrow]]ed [[fund]]s 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]].<ref>{{cite web|url=http://www.sjsu.edu/faculty/watkins/leverage.htm|name=Capital Leverage: Financial Intermediation|org=San Jose State University Economics Department|date=December 9, 2008}}</ref> Leverage involves the use of various financial instruments, including [[options]] and [[futures]].
The financial instruments that can be used to create leverage include options and futures, among others. For example, $1,000 invested in stocks might buy 10 shares of XYZ stock, but the same $1,000 can be invested in five options contracts, thus controlling 500 shares.  
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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.  
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Leverage also refers to the amount of [[debt]] used to finance a firm's [[asset]]s. 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.
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[[Portfolios]], however, become [[risk]]ier with leverage. With too much leverage, a market downturn can wipe out all of the [[equity]] and leave the [[investor]] with more [[debt]] than [[asset]]s.<ref>{{cite web|url=http://www.forbes.com/investoreducation/2007/08/20/leverage-debt-margin-pf-education-in_ty_0820investopedia_inl.html|name=Living With Leverage|org=Forbes.com|date=December 9, 2008}}</ref>
 
   
 
   
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== References ==
 
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Latest revision as of 04:36, 28 July 2016

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.