Leverage (finance)
Leverage in finance means using borrowed money to buy assets or invest in opportunities that can potentially generate higher returns than the cost of borrowing.
Here's an example, imagine you have $10 and you want to buy a toy that is worth $20, but you don't have enough money. Your parents offer to lend you $10 to buy the toy, and you promise to pay them back with interest, which means you will have to return them more than $10.
If you are able to sell the toy for $30, you will have made a profit of $10 ($30 - $20). Since you only invested $10 of your own money, your return on investment is 100% ($10 profit / $10 invested), which is quite good!
However, if you did not borrow the money and just used your own $10 to buy the toy, your profit would have only been $10 ($20 - $10), which is still good, but not as good as the $10 you made when you borrowed money.
This is how leverage works in finance. By borrowing money, you can invest in assets or opportunities that have the potential to generate higher returns than the cost of borrowing. Of course, this also means that if your investment does not generate enough returns to cover the cost of borrowing, you can end up losing money and may have to pay back more than what you originally borrowed.
That's why it's important to use leverage wisely and only when you are confident that your investment has a high chance of generating positive returns.
Here's an example, imagine you have $10 and you want to buy a toy that is worth $20, but you don't have enough money. Your parents offer to lend you $10 to buy the toy, and you promise to pay them back with interest, which means you will have to return them more than $10.
If you are able to sell the toy for $30, you will have made a profit of $10 ($30 - $20). Since you only invested $10 of your own money, your return on investment is 100% ($10 profit / $10 invested), which is quite good!
However, if you did not borrow the money and just used your own $10 to buy the toy, your profit would have only been $10 ($20 - $10), which is still good, but not as good as the $10 you made when you borrowed money.
This is how leverage works in finance. By borrowing money, you can invest in assets or opportunities that have the potential to generate higher returns than the cost of borrowing. Of course, this also means that if your investment does not generate enough returns to cover the cost of borrowing, you can end up losing money and may have to pay back more than what you originally borrowed.
That's why it's important to use leverage wisely and only when you are confident that your investment has a high chance of generating positive returns.
Related topics others have asked about: