Advertising

Leverage

• Borrowing funds in order to invest in securities that have potential to pay earnings at a rate higher than the cost of borrowing.

• See debt leverage.

• The advantage gained by using a lever. It results from the use of fixed-cost assets or funds to magnify returns (or in some cases, losses) to the firm's owners.

• Debt is also called leverage.

• The use of debt financing.

• The extent to which a company uses debt to finance expansion and growth. It is measured by the Debt to Equity and Debt to Capital Ratios. When comparing companies' leverage ratios, do so within the same industry, to be fair.

• Refers to the concept of increasing, multiplying, or magnifying the market impact of an investment. Leverage magnifies both the gains or the losses. In corporate finance, leverage often means the amount of debt to equity. Borrowing can enhance shareholder equity returns because the interest is deductible but the profits remain for the common share investors. For derivative products, little or no margin is required for placing positions. Depending on the instrument, market, exchange and other factors, valuation swings may have to be satisfied by new margin or performance bond monies. For illustrative purposes, a $100,000 bond could be bought for cash. If the market moved one point in price, the investor would make or lose $1,000. A person could acquire market performance of the same bond for an initial deposit of $2,500 via the futures markets. Again, a one point price swing would translate into $1,000, plus or minus. Depending on whom you are you may be able to repo or borrow against this bond for 1-2 percent cash down and finance the difference. As can be seen, paying all cash is effectively 100 percent margin and no leverage. A single futures or comparable derivatives transaction would result in an initial placement of $2,500 leaving $97,500 in reserve, so to speak. Or, one can engage in purchasing 40 contract equivalents which would represent $4 million dollars of bonds with no reserve. This would be result in an initial 40:1 leverage arrangement. Here, if the market rallied by 1 point in price then the investor would profit by $40,000. If the market declined by one point in price, then it would cause a$40,000 loss.

 
 Embedded terms in definition
 Assets
Bond
Borrow
Capital
Cash
Contract
Corporate finance
Debt financing
Debt leverage
Debt to capital ratio
Debt
Derivatives
Derivative
Earnings
Equity
Exchange
Finance
Futures market
Futures
Industry
Interest
Investor
Leverage ratios
Margin
Market
Order
Performance bond
Placement
Plus
Point
Profit
Repo
Reserve
Securities
Share
Valuation
 
 Referenced Terms
 Adjusted present value: Abbreviated APV. The net present value analysis of an asset if financed solely by equity (present value of un-levered cash flows), plus the present value of any financing decisions (levered cashflows). In other words, the various tax shields provided by the deductibility of interest and the benefits of other investment tax credits are calculated separately. This analysis is often used for highly Leveragedtransactions such as a leverage buy-out.

 Assets to equity: The ratio of assets to equity in the company; a measure of Leverage, which has a bearing on the Profitability of the firm.

 Bankruptcy cost view: The argument that expected indirect and direct bankruptcy costs offset the other benefits from Leverage so that the optimal amount of leverage is less than 100% debt financing.

 Capitalization ratios: Show how a firm has financed the investment in assets. There are three capitalization alternatives: debt, preferred equity and common equity.Also called financial Leverage ratios, these ratios compare debt to total capitalization and thus reflect the extent to which a corporation is trading on its equity. Capitalization ratios can be interpreted only in the context of the stability of industry and company earnings and cash flow.

 Clientele effect: The grouping of investors who have a preference that the firm follows a particular financing policy, such as the amount of Leverage it uses.The argument that a firm attracts shareholders whose preferences with respect to the payment and stability of dividends correspond to the payment pattern and stability of the firm itself.

 
 Related Terms
 

<< Levels i, ii and iii Leverage clientele >>

"Green" Banking: Saving the Environment as You Save and Borrow Money: You're probably already recycling paper, glass and plastic. But did you know you also may be able to help save the environment as you do your banking? Here are options that may be available from your bank. More...

Even if you're on the right track, you'll get run over if you just sit there. - Will Rogers

Advertising



Copyright 2009-2018 GVC. All rights reserved.