Sunday, January 22, 2012

Leverage - Analysis

Leveraging in simply increasing your exposure in something with some money that you don't have and thereby inherently increasing the risk.

Typical example for a normal common man would be 'Buying a house' - Where most of the money is given as a loan by the bank and he is thus said to be leveraged.

For a equity investor, few of the other examples would include Stock Futures, Options and Margin Intraday trading.

Without the money in hand, only the risk will be increased in each of the case and typically Leveraging is the concept where you will be get high returns along with high risk.

For example, Reliance is at Rs. 800/- now. you think, it will go Rs. 860/- in next 3 days.

You have Rs. 5000/- in hand, which you can afford to lose. Remember, you shouldn't be taking risk on a capital that is required next day for your need.

Option 1:
Buy 6 shares
- 6 * 800 - Rs.4800 spent.

Profit
- 60 * 6 - Rs. 360/-

Option 2:
Buy 60 shares
- 60 * 800 - Rs. 48000 spent (Rs. 43000 in margin)

Profit
- 60 * 60 - Rs. 3600/-

You can clearly see that Leveraging gives you a greater benefit in rewarding. But it goes without saying that it has higher risk. What if, Reliance goes down?

If you have bought only 6 shares, you can afford to hold it. But if you have bought in margin you are locked. You have to book losses and the losses would be heavy as well.

So, Leveraging would help in having high risk and give high rewards.

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