Leverage

RECENT NEWS
MarketWatch  Nov 26  Comment 
The Federal Reserve Bank of New York quietly marked the end of a painful phase of U.S. economic history Tuesday, saying that a five year run of household debt deleveraging was over.
Forbes  Nov 20  Comment 
Cash outflows from bank loan funds eased slightly to $374 million for the week ended Nov. 19, from $398 million in the previous week, according to Lipper. The latest reading represents the 19th consecutive weekly withdrawal and the 30th outflow in...
Motley Fool  Nov 19  Comment 
Leveraged ETFs have done their job well lately, but there's a catch that makes it unlikely that they'll keep up the pace in the future.
MarketWatch  Nov 14  Comment 
Although low interest rates haven't led to much of an increase in post-crisis risk taking by U.S. banks, lenders have originated an increased number of risky leveraged loans, Federal Reserve Gov. Jerome Powell said Friday at a forum on...
Wall Street Journal  Nov 7  Comment 
U.S. regulators faulted Wall Street banks for “serious deficiencies” in loans that back corporate buyout deals, promising stricter oversight as they continue a tussle with the industry over its involvement in the lucrative market.
New York Times  Nov 5  Comment 
Regulators fear that the stampede into less conventional assets, including leveraged loans, could create bubbles that will later pop, harming banks and the wider economy.
Forbes  Nov 3  Comment 
U.S. leveraged loan issuance dropped to $21.8 billion in October from $62 billion in September as issuers and arrangers alike navigated a cautious, rocky October that saw trading prices on existing loans deteriorate for much of the month.




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Leverage is the use of margin to increase the potential return of an investment. Leverage can also mean the amount of debt a company uses to finance operations. A company with lots of debt and little equity is classified as highly leveraged.

In the securities business, brokers will typically lend 50 percent of the value of stock to be purchased. Some stocks, who may be viewed as exceptionally risky, may not be eligible for margin purchase; the broker will not lend out funds to purchase those securities.

For example, say you buy $1,000 worth of stock in company ABC at $100 per share. You have a total of 10 shares in company ABC. If you wanted to leverage your $1,000 to increase the potential return on your investment, instead of buying stock in ABC you could buy 4 option contracts at $2.50 each ($2.50 x 100 = $250) and control 400 shares instead of just 10 shares. Keep in mind that both risk and reward are magnified with leverage.

When the leveraged securities in the account begin to witness losses, the broker may issue a margin call. When the value of the equity gets close to the value of the loan, the broker will notify the investor that he needs to add more collateral in the form of cash or more securities. If the investor does not meet the margin call, the broker will sell the equities in the account to pay himself back, and give the rest to the investor. This may cause a problem to the investor. The stock may be depressed, poised to come back, but he is forced to transact. This is why holding leveraged positions is risky and is detrimental to some investing strategies.

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