A “double-edged sword” has two cutting edges; in finance, a “double-edged sword” means something that has both potential benefits and liabilities. Financial leverage can multiply gains, but it also multiply losses.
“Leverage is a double-edged sword” is an idiomatic saying that has been cited in print since at least 1951.
Wikipedia: Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:
. A public corporation may leverage its equity by borrowing money. The more it borrows, the less equity capital it needs, so any profits or losses are shared among a smaller base and are proportionately larger as a result.
. A business entity can leverage its revenue by buying fixed assets. This will increase the proportion of fixed, as opposed to variable, costs, meaning that a change in revenue will result in a larger change in operating income.
. Hedge funds often leverage their assets by using derivatives. A fund might get any gains or losses on $20 million worth of crude oil by posting $1 million of cash as margin.
Leverage and risk
The most obvious risk of leverage is that it multiplies losses. A corporation that borrows too much money might face bankruptcy during a business downturn, while a less-levered corporation might survive. An investor who buys a stock on 50% margin will lose 40% of his money if the stock declines 20%.
There is an important implicit assumption in that account, however, which is that the underlying levered asset is the same as the unlevered one. If a company borrows money to modernize, or add to its product line, or expand internationally, the additional diversification might more than offset the additional risk from leverage. Or if an investor uses a fraction of her portfolio to margin stock index futures and puts the rest in a money market fund, she might have the same volatility and expected return as an investor in an unlevered equity index fund, with a limited downside. So while adding leverage to a given asset always adds risk, it is not the case that a levered company or investment is always riskier than an unlevered one. In fact, many highly-levered hedge funds have less return volatility than unlevered bond funds, and public utilities with lots of debt are usually less risky stocks than unlevered technology companies.
What Does Leverage Mean?
1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.
2. The amount of debt used to finance a firm’s assets. A firm with significantly more debt than equity is considered to be highly leveraged.
Forex Leverage: A Double-Edged Sword
by Grace Cheng
Excessive Leverage Can Kill
With a smaller amount of real leverage applied on each trade, you can afford to give your trade more breathing space by setting a wider but reasonable stop and avoiding risking too much of your money. A highly leveraged trade can quickly deplete your trading account if it goes against you as you will rack up greater losses due to bigger lot sizes. Keep in mind that leverage is totally flexible and customizable to each trader’s needs. Having an aim of trading profitably is not about making your millions by the end of this month or this year.
Leverage’s “Double-Edged Sword” Need Not Cut Deep
There’s no need to be afraid of leverage once you have learned how to manage it. The only time leverage should never be used is if you take hands-off approach to your trades. Otherwise, leverage can be used successfully and profitably with proper management. Like any sharp instrument, leverage must be handled carefully - once you learn to do this, you have no reason to worry.
Wiktionary: double-edged sword
from the notion that even as one edge of a two-edged sword can be directed at an enemy or otherwise do your bidding, the opposite edge, pointing back as it does towards you, is at risk of doing you harm
double-edged sword (plural double-edged swords)
1.(idiomatic) A benefit that is also a liability, or that carries some significant but non-obvious cost or risk.
New Methods for Profit in the Stock Market,
With a critical analysis of established systems
By G. A. Drew
Boston, MA: Metcalf Press
Leverage is a double-edged sword.
An analytical and conceptual approach
By Suresh Chandra Kuchhal
Allahabad: Chaitanya Publ. House
Leverage is a double-edged sword. It has got tremendous acceleration of deceleration effect on EBIT as well as EPS.
22 September 1970, Wall Street Journal, “Pork Belly Boom” by John A. Prestbo:
But leverage is a double-edged sword.
Money and Banking:
Financial markets and institutions
By Gary Smith
Reading, MA: Addison-Wesley
But, as everyone says, leverage is a double-edged sword.
A guide for investors and their advisors
By Robert E. Swanson and Barbara Mardinly Swanson
Homewood, IL: Dow Jones-Irwin
Leverage is a double-edged sword, however; just as it multiplies your gain and tax benefits when you are in a good deal, it will multiply and accelerate your losses when you are in a bad deal.
Real Estate Principles and Practices
By Edmund F. Ficek, Thomas P. Henderson and Ross H. Johnson
Columbus, OH: Merrill Pub. Co.
You must remember that financial leverage is a double-edged sword. It magnifies both gains and losses.
Forbes Guide to the Markets:
Becoming a savvy investor
By Marc M. Groz
New York, NY: J. Wiley
Leverage is a double-edged sword. It can bring great returns, or it can cost you your shirt. Unless and until you thoroughly understand securities and the markets in which they trade, leverage may be hazardous to your financial health.
The Financial Express
Margin trading: A double-edged sword
Posted: Monday, May 01, 2006 at 0054 hrs IST
Margin trading is all about leverage. Leverage is a double-edged sword, amplifying losses and gains to the same degree. Because of the amplification effect, if the market moves contrary to expectations, the client may lose lots of money (margin shortage + Interest charged on loan taken from the lender). It is also associated with the portfolio of shares that a client holds. If the portfolio itself is very volatile, leveraging it may bring in certain problems.
How a Goldman hedge fund shrank a third in a week
By Jonathan Keehner - Analysis
NEW YORK | Tue Aug 14, 2007 6:59pm EDT
Leverage was also a big culprit in the recent meltdown of two Bear Stearns Cos BSC.N funds that invested in bonds linked to subprime mortgages.
“Leverage is a double-edged sword,” said Merrill Lynch analyst Richard Bernstein in a research note. “It enhances returns on the upside, but also makes underperformance more rapid and severe.”
Leverage: The Double Edged Sword
Forex Hound Team, Forex Hound
Published 09/26/2007 - 8:09 a.m. EST
Fully understand that leverage–that is, trading on margin–will work for you when you are making a profit, but will also work against you when you predict a market move incorrectly. It is key for a trader to understand the difference between the required margin and the trade size. A margin requirement of $1,000 might actually mean a trade size of $100,000. This means that a 2% movement in the price of the instrument is actually a 2% move on $100,000, rather than $1,000.
How to profit from event-driven arbitrage
By Thomas Kirchner
Hoboken, NJ: John Wiley & Sons
LEVERAGE AND OPTIONS
Merger arbitrage is a low-volatility strategy. As such, it lend itself to the use of leverage. Because leverage is a double-edged sword, amplifying both returns and losses, it is risky to use on investment strategies that produce widely fluctuating returns.
Money Talks News
Rent or Own Your Home? New Rules
By Stacy Johnson | Aug 23, 2010
Rule No. 1: Leverage is a double-edged sword
Putting up a little of your own money, then using someone else’s to pay for an asset, is called leverage. Leverage only makes sense in one circumstance: when the value of what you’re buying is going up by more than the interest you’re paying. So if you’re paying 5-percent interest on a mortgage, the transaction makes sense if the house you’re buying appreciates by more than 5 percent a year.
New York City • Banking/Finance/Insurance • (1) Comments • Thursday, January 27, 2011 • Permalink
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