Leverage (finance)
In finance, leverage (sometimes referred to as gearing in the United Kingdom, or solvency in Australia) is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:
- A public corporation may leverage its equity by borrowing money. The more it borrows, the less equity capital it needs, so any profits or losses are shared among a smaller base and are proportionately larger as a result.
- A business entity can leverage its revenue by buying fixed assets. This will increase the proportion of fixed, as opposed to variable, costs, meaning that a change in revenue will result in a larger change in operating income.
- Hedge funds often leverage their assets by using derivatives. A fund might get any gains or losses on $20 million worth of crude oil by posting $1 million of cash as margin.
Read more about Leverage (finance): Measuring Leverage, Leverage and ROE, Leverage and Risk, Worked Example, Leverage and Bank Regulation, Leverage and The Financial Crisis of 2007–2009