imported>Doug Williamson |
imported>Doug Williamson |
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| | An asset's ability to be turned into cash quickly and without significant loss compared with current market value. |
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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).
| | An entity’s ability to pay its obligations when they fall due, especially in the short term. |
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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 />
| | An entity's ability to source additional funds to meet its obligations, including in the medium and longer term. |
| 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 />
| | A financial ratio designed to measure an entity's ability to meet its obligations when they fall due. |
| 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.
| | For example, the ''current ratio'' or the ''quick ratio''. |
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| ==Leveraging up==
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| To 'leverage up' means to increase the level of gearing in an operational or financial structure. The intention of leveraging up is to improve expected net results. <br />
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| A consequence of leveraging up 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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| <span style="color:#4B0082">'''''Example 2: Virgin's loan notes secured on Heathrow landing slots'''''</span>
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| :"Virgin Atlantic Airways secured an impressive £220m senior secured note transaction using the airline's take-off and landing slots at London Heathrow Airport. It is the first time in European air travel history that airport slots have been leveraged in this way.
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| :''The Treasurer magazine, February 2017 p25 - Deals of the Year - Bonds below £500m winner.''
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| ==Leverage in banking==
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| Banks tend to have very high levels of leverage, compared with non-financial corporates.
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| Maximum levels of leverage are established by prudential regulation, including regulatory leverage ratios.
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| Leverage ratios in banking are usually defined as the ratio of total balance sheet assets to equity.
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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 3: 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]] | | * [[Authorisation]] |
| * [[Deleverage]] | | * [[Authority limits]] |
| * [[Equity]] | | * [[Cash forecasting]] |
| * [[Gearing]] | | * [[Cash pool]] |
| * [[Leverage Ratio]] | | * [[Current ratio]] |
| | * [[Illiquid]] |
| | * [[Liquidation]] |
| | * [[Liquidity management]] |
| | * [[Liquidity premium]] |
| * [[Liquidity risk]] | | * [[Liquidity risk]] |
| * [[Prudential Regulation Authority]] | | * [[Money management]] |
| * [[Stability]] | | * [[Quick ratio]] |
| | * [[Security]] |
| | * [[Solvency]] |
| | * [[CertICM]] |
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| ==Other links== | | === Other resources === |
| [http://www.treasurers.org/node/8012 Masterclass: Measuring financial risk, The Treasurer, July 2012] | | *[[Media:2015_06_June_-_Safety_first.pdf| Safety first, The Treasurer, 2015]] |
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| [[Category:Corporate_finance]] | | [[Category:Liquidity_management]] |
