Leverage

Leverage refers to the borrowed funds or other type of financial instruments that is used to enhance the potential return from an investment. The debt that is used by a company to finance its assets is also known as leverage. If the company has a higher debt in comparison with equity then in such cases that company will be seen as a highly leveraged one.

Leverage for Futures

As far as futures are taken under consideration, a trader does not have to contribute a lot in the capital but only a fraction if he mainly trades on leverage. Leverage is something that makes the future trading quite attractive to many. Considering the fact that the initial deposit is a smaller portion of the contracts cash value, a trader can realise hefty profits in comparison with the amount they outlay.

However, an adverse movement of the price can cause the reverse situation. Many traders rely on stop loss for avoiding bigger losses as it allows them to exit the market with a smaller loss instead of holding onto the losing position. However, they can re-enter the market once the scenario improves. It is important for an investor to keep in mind that a stop loss may not provide him the assurance that he will be able to exit a contract precisely at the predetermined level since gapping or slippage can play a role there.

Use of Leverage for Companies

You will find lots of companies that rely on debts for financing their operations, something that allows them to increase leverage since in that case they can invest in the business operations without getting concerned about a high level of equity. Say for example, a company has been formed by the investors who invested $10 million in it. This means the company has a $10 million worth of equity which will be used by the company to operate. Now if the company raises another $50 million through debt financing then it will be able to invest as much as $60 million in its operations in total which will allow the shareholders to enhance the value of their investments. Leveraging a business is considered vital for the investors as well as for the firm where they are investing.

Risks of Leveraging

However, leverage does come up with greater amount of risk as well. Say for example if an investor goes for investing through leveraging the investment and if the business fails, then the investor will have to incur a greater loss because of the leverage in comparison with the loss he would suffer if the investment was not leveraged. As far as leverage is taken under consideration, it can amplify the gains for the company as well as the losses. This is why a company needs to be extremely careful when it comes to using leverage in operations. It needs to consider the fact that although leverage can help it to produce profit for the shareholders but if things go wrong then leverage can magnify the negative impacts for both the company and shareholders as well.