imported>Doug Williamson |
imported>Doug Williamson |
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| | ''Banking.'' |
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| | The UK Prudential Regulatory Authority's Policy Statement 7 of 2013. |
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| __TOC__
| | PS7/13 sets out the related rules and supervisory statements to implement the EU's CRD IV in the UK. |
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| ==Leverage calculation==
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| Leverage is most commonly defined as debt divided by Debt plus Equity
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| = D / (D + E).
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| <span style="color:#4B0082">'''Example 1: Leverage calculation'''</span>
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| If the amounts of debt and equity were equal then leverage under this definition would be calculated as:<br />
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| 1 / (1 + 1) = 50%.
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| ==Broader definitions==
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| The term 'leverage' is also used in a broader sense to refer to the amount of debt in a firm's financial structure.<br />
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| Used in this broader sense, 'leverage' means very much the same as 'gearing'. <br />
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| However, leverage and gearing are normally quantified by different calculations.
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| ==Leveraging up==
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| To increase the level of gearing in an operational or financial structure. The intention of leveraging is to improve expected net results. <br />
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| A consequence of leveraging is normally to increase financial risk.<br />
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| Many financial disasters have been a consequence of leveraging up excessively in this way in earlier periods.
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| ==Leverage in derivatives trading==
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| Leverage is also the ratio of the total value of a derivatives contract relative to the size of the required margin or collateral. <br />
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| <span style="color:#4B0082">'''Example 2: Leverage in derivatives trading'''</span>
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| 10:1 leverage means that an investor needs to provide GBP 10,000 in order to control a position of a GBP 100,000 value futures contract while taking responsibility for any losses or gains their investments incur. <br />As a result if the value of the contract rose by 10% to GBP 110,000, there will be a potential profit of 100% (= 10 x 10%) relative to the amount of GBP 10,000 invested.<br /><br />
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| Similarly if the value were to fall by 10% to GBP 90,000, there would be a loss of the all the initial investment.<br />
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| Again the change in the value of the total position is 10 x the 10% movement in the value of the contract.<br />
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| In this case, a loss of 10 x 10% = 100%.<br />
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| It is also possible to lose more than the entire value of the initial investment.<br />
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| This is why derivatives trading can be so dangerous for the investor.
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| == See also == | | == See also == |
| * [[Debt]] | | * [[Additional Tier 1]] (AT1) |
| * [[Deleverage]] | | * [[Basel II]] |
| * [[Gearing]] | | * [[Basel III]] |
| * [[Leverage ratio]] | | * [[Capital adequacy]] |
| | | * [[Capital Requirements Directive]] |
| | | * [[Common Equity Tier 1]] (CET1) |
| ==Other links==
| | * [[CRD IV]] |
| [http://www.treasurers.org/node/8012 Masterclass: Measuring financial risk, The Treasurer, July 2012] | | * [[Prudential Regulation Authority]] |
| | * [[Tier 2]] (T2) - Tier 2 capital |
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| [[Category:Corporate_finance]] | | [[Category:Accounting,_tax_and_regulation]] |
