Leverage in finance refers to the use of borrowed funds to buy an investment, with the expectation that future profits will be more than the cost of borrowing). It is a technique used to amplify returns from an investment or project. Leverage can arise in a number of situations, such as when securities like options and futures are effectively bets between parties where the principal is implicitly borrowed/lent at interest rates of very short treasury bills, or when equity owners of businesses leverage their investment by having the business borrow a portion of its needed financing).

Financial leverage is the use of borrowed capital as a funding source when investing to expand the firms asset base and generate returns on risk capital. It is an investment strategy of using borrowed money to increase the potential return of an investment. Leverage can also refer to the amount of debt a firm uses to finance assets. Financial leverage signifies how much debt a company has in relation to the amount of money its shareholders invested in it, also known as its equity. A company with a high debt-to-equity ratio is generally considered a riskier investment than a company with a low debt-to-equity ratio.

Leverage can offer investors a powerful tool to increase their returns, although using leverage in investing comes with some big risks, too. Analysts need to understand a company’s use of leverage to assess its risk and return characteristics. Understanding leverage can also help in forecasting cash flows, allowing the selection of an appropriate discount rate for finding a firm’s present value. Within an investment bank, a division in charge of leveraged finance is responsible for services related to a client’s leveraged buyouts. These services typically include structuring, managing, and advising on debt financing for acquisitions.