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Leverage

Reviewed by Sujaini | Updated on Oct 05, 2020

Catalogue

What is Leverage?

Leverage benefits from using borrowed capital as a source of financing while investing in expanding the company's asset base and increasing returns on investment capital. Leverage is an investment technique of using borrowed money, precisely, the use of different financial instruments or borrowed capital to maximise an investment's potential return.

Also, leverage may refer to the amount of debt a firm uses to fund assets. When a company, property, or investment is referred to as "highly leveraged", that means the item has more debt than the equity.

Breaking Down Leverage

Leverage is the use of debt to pursue any investment or project. The consequence is a calculation of future project returns. Simultaneously, debt would also increase the possible downside risk if the investment will not turn out.

Both investors and enterprises use the leverage concept. Investors use leverage to increase the returns that investment can provide significantly. They maximise their investments through the use of different instruments, including options, futures, and margin accounts.

The companies can use leverage to fund their properties. In other words, companies can use debt financing to invest in business operations in an attempt to increase shareholder value instead of issuing stocks to raise capital.

Investors that are uncomfortable to actively use leverage have several ways to control leverages indirectly. In the normal course of their business, they can invest in companies that use leverage to finance or expand operations without increasing their outlay.

Difference Between Leverage and Margin

Though interconnected, because both include borrowing, leverage and margin are not identical. Leverage applies to debt calculation because the margin is debt or borrowed capital a business uses to invest in other financial tools.

A margin account lets you borrow money from a broker to purchase shares, options, or futures contracts at a fixed interest rate in expectation of receiving substantially high returns.

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