Leverage

1. Definition

Leverage is the use of debt (borrowed capital) to undertake an investment or project. * The term comes from physics: using a lever to lift a heavy object with a small amount of force. * In finance, it allows you to control a large asset base with a small amount of your own money (Equity).

2. The Power of OPM

OPM (Other People's Money) is the secret sauce of capitalism. * Example: Buying a \$500,000 house with \$100,000 cash (Down payment) and a \$400,000 mortgage. * If the house price rises by 10% (to \$550,000), your equity grows from \$100,000 to \$150,000. * You made a 50% Return on Investment (ROI) on a 10% asset move.

3. The Double-Edged Sword

Leverage magnifies both gains and losses. * If the asset price drops, the loss is deducted entirely from your equity, not the loan. * Deleveraging: When the market turns, investors rush to sell assets to pay back debt, often causing a market crash.

4. Common Forms

• Financial Leverage: Using corporate debt to finance business operations.
• Investment Leverage: Buying stocks on margin, trading options/futures, or real estate mortgages.