Business and Personal Finance Dictionary

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• LEVERAGE
  
  Refers to the concept of increasing, multiplying, or magnifying the market impact of an investment. Leverage magnifies both the gains or the losses. In corporate finance, leverage often means the amount of debt to equity. Borrowing can enhance shareholder equity returns because the interest is deductible but the profits remain for the common share investors. For derivative products, little or no margin is required for placing positions. Depending on the instrument, market, exchange and other factors, valuation swings may have to be satisfied by new margin or performance bond monies. For illustrative purposes, a $100,000 bond could be bought for cash. If the market moved one point in price, the investor would make or lose $1,000. A person could acquire market performance of the same bond for an initial deposit of $2,500 via the futures markets. Again, a one point price swing would translate into $1,000, plus or minus. Depending on whom you are you may be able to "repo" or borrow against this bond for 1-2 percent cash down and finance the difference. As can be seen, paying all cash is effectively 100 percent margin and no leverage. A single futures or comparable derivatives transaction would result in an initial placement of $2,500 leaving $97,500 in reserve, so to speak. Or, one can engage in purchasing 40 contract equivalents which would represent $4 million dollars of bonds with no reserve. This would be result in an initial 40:1 leverage arrangement. Here, if the market rallied by 1 point in price then the investor would profit by $40,000. If the market declined by one point in price, then it would cause a $40,000 loss.
  
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