What does financial leverage allow an investor to do?

Financial leverage refers to the use of borrowed capital to increase the potential return on investment. When an investor employs financial leverage, they are effectively amplifying their exposure to an asset, allowing them to invest more than they could with just their own capital. This amplification can lead to higher potential returns if the investment performs well.

By borrowing funds, the investor can purchase a larger quantity of an asset than they would be able to afford using only their own resources. For instance, if an investor puts down a small percentage of the investment cost as equity and borrows the remainder, any gains (or losses) on the total investment will be calculated on the larger amount, thus enhancing the returns if the investment appreciates.

However, it is essential to note that while financial leverage can increase potential returns, it also comes with increased risk. If the investment decreases in value, the losses can be magnified just like the gains. This is why it is crucial for investors to understand the implications of using leverage in their financial strategies.