What does "leverage" mean in financial terms?

Leverage in financial terms specifically refers to the use of borrowed funds to amplify the potential return on investment. When an investor or company borrows money, they can invest that amount alongside their own capital, effectively increasing the total investment size. This can lead to greater profits if the investment performs well, but it also exposes the investor to higher risks—if the investment loses value, the borrowed amount must still be repaid, which can result in significant financial strain.

Understanding leverage is crucial because it illustrates how capital can be efficiently utilized for potential gains. For instance, real estate investors often use leverage by taking out mortgages to purchase property, allowing them to potentially earn significant returns on their investments with a relatively small initial capital outlay. This concept is foundational in finance and investment strategies, influencing decisions in various markets.