Debt Dictionary

Leverage

Investment Dictionary -> Leverage

The term leverage covers the use of debt for the purpose of partial investment financing. The goal is to boost the potential returns on the investment in question. The term is also used to indicate the degree to which businesses use borrowed capital to finance their projects. Highly leveraged companies are exposed to increased risks of bankruptcy in case that they are unable to repay their outstanding debts. In addition, it may be difficult to find new lenders for future projects.

Financial leverage refers to borrowed funding which is subsequently reinvested, bringing higher returns than the cost of the interest on the loan. In general, the debt to equity ratio of the company indicates its leverage. It is calculated by dividing the total liabilities by the shareholders` equity. Only long term debt is included in the calculation of the company’s financial leverage.

Leverage also refers to margin accounts in which the brokers lend cash for the purchase of securities. The loan is secured by collateral in the form of securities or cash. In case that the value of the shares drops significantly, the margin account holder is obliged to deposit additional money. Alternatively, he has to sell a certain portion of his shares.

Further along, real estate leverage is an effective method to increase the returns on investments. In essence, this type of leverage refers to the use of borrowed money for the purchase of real estate property. It is a known fact that most of the time, real estate properties increase their value with the passage of time. Moreover, real estate is a long term stable investment. Leverage works best for the properties which appreciate at the current moment. Good neighborhood, property history, as well as home improvements add to the value of the property. For instance, renovation and refurbishment of the rooms or the conversion to wooden floor provide some of the best rates of returns in home improvement.


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