1. Leverage
The use of debt financing, or property of rising or falling at a proportionally greater
amount than comparable investments. For example, an option is said to have high
leverage compared to the underlying stock because a given price change in the
stock may result in a greater increase or decrease in the value of the option. Also,
commonly known as Gearing in Europe.
Leverage
1. To use debt to finance an activity. For example, one usually borrows money in
the form of a mortgage to buy a house. One commonly speaks of this as leveraging
the house. Likewise, one leverages when one uses a margin in order to
purchase securities.
2. The amount of debt that has been used to finance activities. A company with
much more debt than equity is generally called "highly leveraged." Too much
leverage is thought to be unhealthy, but many firms use leverage in order to expand
operations.
Leverage. Leverage is an investment technique in which you use a small amount
of your own money to make an investment of much larger value. In that way,
leverage gives you significant financial power.
For example, if you borrow 90% of the cost of a home, you are using the leverage
to buy a much more expensive property than you could have afforded by paying
cash.
If you sell the property for more than you borrowed, the profit is entirely yours.
The reverse is also true. If you sell at a loss, the amount you borrowed is still due
and the entire loss is yours.
Buying stock on margin is a type of leverage, as is buying a futures or options
contract.

2. Leveraging can be risky if the underlying instrument doesn't perform as you
anticipate. At the very least, you may lose your investment principal plus any
money you borrowed to make the purchase.
With some leveraged investments, you could be responsible for even larger losses
if the value of the underlying product drops significantly
Leverage
The effect borrowed money has on an investment; the concept of borrowing money
to buy an asset that will appreciate in value, so that the ultimate sale will return
profits on the equity invested and on the borrowed funds.
Example: Mark and Amy each have $100,000 to invest. They can buy rental
houses for $100,000 per house and collect rent of $1,100 per month for each
house. At the end of 5 years, they will be able to liquidate and sell their houses for
$150,000 each. Amy uses leverage and Mark does not.
Leverage
What Does Leverage Mean?
(1) The use of various financial instruments or borrowed capital, such as margin, to
increase the potential return of an investment.
(2) The amount of debt used to finance a firm's assets. A firm with significantly
more debt than equity is considered highly leveraged.
Investopedia explains Leverage

3. (1) Leverage can be created through options, futures, margin, and other financial
instruments. For example, say you have $1,000 to invest. This amount could be
invested in 10 shares of Microsoft stock, or you could increase your leverage by
buying five option contracts worth $1,000. You then would control 500 shares
instead of 10. (2) Most companies use debt to finance operations. By doing so, a
company increases its leverage because it can invest in business operations without
increasing its equity. For example, a company started with an investment of $5
million from investors has equity of $5 million; this is the money the company
uses to operate. If the company uses debt financing by borrowing $20 million, the
company now has $25 million to invest in business operations and more
opportunity to increase value for shareholders. Leverage helps both the investor
and the firm invest and operate. However, it comes with greater risk. If an investor
uses leverage to make an investment and the investment moves against the
investor, his or her loss is much greater than it would have been if the investment
had been made with cash; leverage magnifies both gains and losses. In the business
world, a company can use leverage to try to generate shareholder wealth, but if it
fails to do so, the interest expense and credit risk of default can destroy shareholder
value.
LEVERAGE RATIOS
Debt to Assets Ratio = Total Liabilities/Total Assets
Debt to Equity Ratio = Total Liabilities/Total Equity
Times Interest Earned = Operating Income/Interest Expense
A leverage ratio is a comparison of a combination of a company's debt, equity,
assets and interest payments to ascertain its long-term solvency and ability to meet
its financial obligations. Leverage, or gearing, refers to the use of loans or other
forms of debt to finance acquisitions or investments. The goal of using these
financing options is to earn a higher rate of return than the rate of interest on the
loan and amplify gains. Companies with a high degree of leverage are considered
risky and highly vulnerable to economic downturns because they must continue to
meet obligations to the debt in spite of poor production or sales.
The three most commonly employed leverage ratio formulae are the debt-to-equity
ratio, thedebt ratio, and interest-coverage ratio. Acceptable leverage ratios are
determined by comparison to ratios of other entities in the same industry. They are
also determined by tracking of the same ratio for one company over time.
AdChoices

4. The debt-to-equity ratio is the most commonly used leverage ratio, providing a
measure of a company's liabilities in relation to the funds given by shareholders. A
greater proportion of shareholder capitalization provides a safety net and is viewed
as a sign of financial strength. This ratio is calculated by dividing the total debts by
the total equity of the shareholders. The lower the number, the less gearing
or leverage that the company is using. Since the leverageratio is used to assess
long-term solvency, many companies deduct the accounts payable, a short-term
debt, from the total debt figure before completing the ratio calculation.
Another type of leverage ratio, the debt ratio or debt-to-asset ratio, indicates what
portion of the company's assets is financed by debt. The debt ratio is determined by
dividing the company's total debts by its total assets. A higher debt ratio signifies a
higher degree ofleverage used by the company. The operating liabilities are often
deducted from the total debts before calculating the ratio.
Alternatively, the interest-coverage ratio indicates the relative ease with which a
company can pay the interest associated with its debt. The formula divides the
amount earned per share by the interest expenses, before interest and taxes are
subtracted from the earnings. In general, an interest-coverage ratio of less than two
is a red flag that the company may be unable to fulfill its interest obligations.
This ratio is monitored as a critical indicator of a company's viability since even a
deeply indebted company may be able to make its interest payments. Once
this ratio falls, default or bankruptcy may be imminent.