The effect of fixed charges (i.e., debt interest or preferred dividends, or both) on per-share of common stock. Increases or decreases in income before fixed charges result in magnified percentage increases or decreases in earnings per common share. Leverage also refers to seeking magnified percentage returns on an investment by using borrowed funds, margin accounts or securities which require payment of only a fraction of underlying security value (such as rights, warrants or options).
What is Leverage?
Leverage refers to the use of borrowed money to increase the size of an investment, with the goal of generating greater returns. In finance, leverage is achieved by borrowing money to purchase assets such as stocks, bonds, real estate, or commodities. By using leverage, investors can control a larger investment for a smaller amount of money, magnifying the returns of their investment.
For example, an investor who leverages their investments by using margin, which is borrowing money from a broker, can buy more stock than they could with just their own capital. If the stock price increases, the investor can realize a larger return on their investment due to the leverage effect. On the other hand, if the stock price decreases, the investor’s losses are also magnified.
Leverage can be a double-edged sword. While it can magnify investment returns, it can also magnify investment losses, making it a higher risk strategy. The amount of leverage used in an investment can also impact the volatility of returns, and investors should consider their risk tolerance and financial goals before deciding on the level of leverage to use.
Leverage can be found in various forms, including margin accounts, options, futures, and real estate investment trusts (REITs), among others. It is important to understand the terms and conditions of the leverage product being used, as well as the associated risks, before making an investment decision.
