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Simple English definitions for legal terms
capital leverage
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A quick definition of capital leverage:
Capital leverage is when a business borrows money to make more money. They use the borrowed money to invest in things that they think will make a profit. The goal is to make more money than they have to pay back in interest. This is called leverage. It's like using a ladder to reach something high up. The borrowed money is the ladder that helps the business reach higher profits. However, if the investments don't make enough money, the business may have trouble paying back the borrowed money and could end up in financial trouble.
A more thorough explanation:
Definition: Capital leverage refers to the use of borrowed funds by a business to earn a higher return than the interest rate paid on the borrowed funds. It is a financial strategy that aims to increase profits by using debt to finance investments.
- A company borrows money from a bank to invest in a new project that is expected to generate a return of 15%. The interest rate on the loan is 8%. By using capital leverage, the company can earn a profit of 7% (15% - 8%) on the borrowed funds.
- An individual investor buys stocks on margin, which means they borrow money from a broker to purchase more shares than they could with their own funds. If the stock price increases, the investor can earn a higher return than if they had only invested their own money. However, if the stock price decreases, the investor may lose more money than they would have without using capital leverage.
These examples illustrate how capital leverage can be used to increase returns on investments. However, it is important to note that using debt to finance investments also increases the risk of losses if the investments do not perform as expected. Therefore, capital leverage should be used carefully and with a thorough understanding of the risks involved.