It stems from using debt to finance an investment. This debt creates a financial cost (interest), but if the investment loan generates a greater income to interest payable, the surplus goes to increase the company's profit.
An example of the usefulness of this concept has been in the speculation on the market for housing. Investors buy a home, pay a small part and the financial rest is funded low interest (around 4 annually). Within a few months, housing has appreciated greatly.
For example, a house purchased for 100,000 euros, business was paid 20,000 euros banking and the remaining 80,000 are funded by online banking mortgage. A year, sold the house and returned 150,000 mortgage, paying interest of 3,000. Had he bought the house exclusively with own funds, the yield was 50 -are obtained 50,000-euro profit cash loan (increase in value of assets), but 80,000 in funding to bank loans be provided will receive accounting 20,000 euros debt 47,000 ( 150,000 - 80,000 - 3,000 - 20,000) profit, ie a fund profit of more than 200 . And another 80,000 were for other investments.
Same goes for the bank company: not all the investment financed with own funds, the stock quotes benefit is received in terms of what is invested more (provided that the asset will generate more revenue than the cost of interest), and credit therefore profitability too. Instead, there is a greater cost in the transaction (the interest stock market rate), which mortgage increases the risk he has loans benefit. In investments addition, increasing debt, there is greater risk of insolvency. Finally, increases uncertainty, because not really know investment the future evolution of the income generated by the assets.
In its mathematical expression, the financial business loan leverage associated return on investment (ROI banks or insurance profitability) stock with the return on equity (ROE or financial return) and can be approximated from an additive stocks from a multiplicative:
ROE ROI x L
ROE ROI L
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June cash 16 (Bloomberg) - European Central Bank council member Ewald Nowotny warned against raising interest rates and ending emergency measures stock quote soon, says the top priority should be to the lending economic growth in the euro region.
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June 16 (Bloomberg) financial services - Dallas Area Rapid Transit is planning to 1 billion for its light-rail link to the largest municipal debt supply, the bulk of the Building America Bonds whose interest costs are federal subsidized. Chairman of the Visiting Committee of Harvard University?s Weatherhead Center for International Affairs has a Doctorate of Law from the Harvard Law School.
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June 16 (Bloomberg) - The yen against higher performing currency business loans as a decline in Asian equities increased demand for analyst safer investments.
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June 16 (Bloomberg) - jobs Chiles central bank's interest to half a percentage point to a record today and said that will likely keep market the low rate for a longer period than investors expect.
