imported>Doug Williamson |
imported>Doug Williamson |
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| | ''UK Pensions.'' |
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| | An educational charity providing non-political, independent comment and analysis on public pension policy and provision of retirement income in the UK. |
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| ==Leverage calculation==
| | [[Category:Manage_risks]] |
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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 '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 [rights to use] 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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| <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 ==
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| * [[CRD IV]]
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| * [[Debt]]
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| * [[Deleverage]]
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| * [[Equity]]
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| * [[Gearing]]
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| * [[Leverage Ratio]]
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| * [[Liquidity]]
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| * [[Liquidity risk]]
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| * [[Prudential Regulation Authority]]
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| * [[Stability]]
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| ==Other links==
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| [http://www.treasurers.org/node/8012 Masterclass: Measuring financial risk, The Treasurer, July 2012]
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| [[Category:Corporate_finance]] | |