Leverage: losses grow too
Leverage is increasing exposure using debt or another mechanism.
It can magnify both gains and losses relative to the money you invested yourself. The debt and interest do not disappear when the asset falls. In some situations you can lose more than your equity and be required to add money or sell. The lesson demonstrates risk; this is not leveraged trading.
You have 100 ₪, you borrow another 100 and invest 200. After a 25% drop the asset is worth 150. After repaying the 100 debt there remain 50, before interest: a 50% loss on your money.
Explain the example in your own words and check the calculation.
Investor.gov · Leveraged Accounts ↗Check your understanding
In the example, what is the loss on equity before interest?
- 25%
- 50%
- 0%
Answer and explanation
50%. 50 remain out of the 100 that were yours.
When the investment falls, the debt…
- Is automatically erased
- Remains according to the loan terms
- Becomes a profit
Answer and explanation
Remains according to the loan terms. Obligations must be met even if the asset lost value.
Continue learning
Loan: the money now, the repayment later — A loan is money you receive with an obligation to repay according to agreed terms.