What Is Leverage?

Leverage is the use of borrowed money to enhance the returns of any investment. Using leverage, an investor is able to achieve the returns of a very large investment whilst only providing the capital for a small investment. Unfortunately, as well as enhancing returns leverage will also magnify losses. An example of the pros and cons of leverage is below:

  • A hedge fund has $10 million of its own money
  • In year 1, the fund has a good year and returns 10%, or a $1 million profit
  • This is a 10% return on equity ($1,000,000 / $10,000,000)
  • In year 2, the fund borrows $90 million in the money markets and has to pay $5 million per year to service the debt
  • The return in year 2 is 10% again, or $10 million
  • After subtracting the $5 million to service the debt, total profit is $5 million, which is 50%, return on equity ($5,000,000 / $10,000,000)
  • Simply by using borrowed money, the fund has increased its returns from 10% to 50%
  • In year 3 the market turns against the fund, and they experience a loss of 10%
  • This is a loss of $10 million, plus the $5 million to service the debt, which is a total cost of $15 million. This is more than the $10 million of equity in the fund, so it is bankrupt

To learn more about this concept and become a master at LBO modeling, you should check out our LBO Modeling Course. Learn more here.

Module 1: Introduction

Module 2: LBO The Big Picture

Module 3: Valuation and Transaction Assumptions

Module 4: Sources and Uses: The Theory

Module 5: Sources and Uses: Application to Nike Case

Module 6: P&L Projections & LBO Adjustments

Module 7: Debt Schedule

Module 8: Balance Sheet and Adjustments

Module 9: Taxes

Module 10: Exit, Returns, & Sensitivity Analysis

Bonus Module A) Purchase Price Accounting

Bonus Module B) Dividend Recap

Bonus Module C) Add-on Acquisition Build

Learn More Here

Related Terms

Return to Finance Dictionary

 

Start Discussion

Popular Content See all

The lighter side of IB! (Hopefully)
+46IBby 1st Year Analyst in Investment Banking - Mergers and Acquisitions">Analyst 1 in IB-M&A
Why aren't Asians/Indians/Middle Eastern considered diversity
+20IBby Intern in Investment Banking - Industry/Coverage">Intern in IB - Ind
Is Finance the back office of society?
+12OFFby 1st Year Analyst in Investment Banking - Industry/Coverage">Analyst 1 in IB - Ind
Making the first move as a woman?
+12OFFby Intern in Investment Banking - Generalist">Intern in IB - Gen
Leaving New York
+10IBby Intern in Investment Banking - Industry/Coverage">Intern in IB - Ind

Total Avg Compensation

October 2020 Investment Banking

  • Director/MD (17) $704
  • Vice President (49) $326
  • Associates (265) $228
  • 3rd+ Year Analyst (36) $168
  • 2nd Year Analyst (147) $159
  • Intern/Summer Associate (137) $141
  • 1st Year Analyst (583) $129
  • Intern/Summer Analyst (558) $82

Leaderboard See all

1
LonLonMilk's picture
LonLonMilk
98.4
2
Jamoldo's picture
Jamoldo
98.3
3
Secyh62's picture
Secyh62
98.2
4
CompBanker's picture
CompBanker
97.9
5
redever's picture
redever
97.7
6
Addinator's picture
Addinator
97.6
7
frgna's picture
frgna
97.5
8
bolo up's picture
bolo up
97.5
9
NuckFuts's picture
NuckFuts
97.5
10
Ricky Rosay's picture
Ricky Rosay
97.3