Financial leverage amplifies both gains and losses and underpins private equity and hedge funds

Evidence

The financial strategy of using borrowed capital to acquire an asset, risking that the future profits will outweigh the cost of borrowing. Named after the concept of a lever in physics, whereby a small input force is amplified into a larger output force, financial leverage increases scale and amplifies smaller amounts of capital into potentially larger profits, multiplying gains. However, losses are also multiplied and thus financial leverage is a risky investment technique available only to large, wealthy investors and firms. Private equity firms and hedge funds are predicated on using high levels of risky financial leverage. — Andrew deWaard, Derivative Media, 491

Categorization

Category: Definitional Content

• DEFINE: Defines financial leverage via the physical lever analogy and ties it to PE and hedge fund practice.

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