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What Is Leverage?

Date Added: April 25, 2012 01:53:56 PM

A very straightforward explanation is simply to what extent is borrowed money used to finance the investments one makes so that one's profit is the margin between the consideration one is paying for the loan and the profit one makes from an investment.

Like all simplistic explanations it does not go far enough so let us look at an example. On forex trading sites the smaller investor often comes to the market with a smallish stake, say 10,000 Euros. Through leverage he is able to buy a 100,000 Euros worth of currency. If all goes well and he sells at a profit he repays the 90,000 Euros he has borrowed and keeps the profit he has made. Thus he has utilized leverage to maximize his profit which far exceeds the profit he could have made only using the actual asset he holds. (Of course if his trading is unsuccessful he could lose his entire stake).

This is the principal of leverage that may be used in the investment strategy of a hedge fund where the ability to used borrowed funds to maximize the margins on certain deals is utilized with impunity as a hedge fund is fairly lightly regulated. The same is not true of an investment fund where there are strict regulations applied to prevent possible losses being inflicted on the investors and thus on these instruments the amount of leverage that may be used is restricted. Luxif in Luxemburg has a very successful record when it comes to the use of leverage in the investment strategy of both their hedge funds and their investment funds.