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Financial leverage explained

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silence Hi this is Brandon Jackson director of Finance & Analytics here at Stonegate. Today's topic is leverage. Leverage is the effect that's created when you borrow money to purchase an asset. When a business want to purchase an asset - let's say - an asset costing $100,000 dollars, they have two options. They can spend their own money or they can borrow money and spend part of their own money to purchase it. Assuming that they spent their own money, they own 100%. So, if down the road, the asset goes up in value 25% and you're able to sell it for $125 (thousand), they make the difference between the purchase price and the sales price which represents an increase in what they put in of 25% or $25,000 dollars. Now it goes the other way too. If their asset went down in price after they purchase it and they sell it for 75 they experience a loss of 25% and end up with a loss of $25,000 dollars on the original $100,000 that they put in to purchase the asset. Leverage creates a multiplier effect of gains or losses. Take for instance the situation where you're buying the same $100,000 dollar asset but you're able to borrow half the money to do it. So the firm puts in 50 and the bank puts in 50 for the total purchase price, and on down the road, let's say the asset appreciates the same 25%. In this case, you sell here for 125 but you still have to pay back this fifty grand loan, which leaves you $75,000 dollars. So the difference of 75 to the 50 that you put in represents a profit of $25,000 dollars or 50% on the original capital you put in. That sword cuts the other way too. If the asset goes down in price, or value, and you're only able to sell it for $75,000 dollars, you still owe the bank $50,000 dollars which leaves you with 25. Clearly when you pay 50 to get in and you come out with half the amount of money, 25, you have a return on your equity of a loss of 50%. This is a critically important concept to remember when margin trading. Although you can boost your returns and enjoy a return of 50% verses 25% you also open the door for losses that cut the other way and you can lose half or more of your own money due to paid depreciation in the value of the underlying asset. Thanks for tuning in.

Video Details

Duration: 3 minutes and 19 seconds
Country: United States
Language: English
Producer: Stone Gate
Director: Stone Gate
Views: 32
Posted by: grayeb on Aug 2, 2012

Una descripción sencilla de apalancamiento financiero utilizando ejemplos

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