What does "financial leverage" involve?

Financial leverage refers to the use of borrowed funds to finance an investment with the goal of amplifying the potential return on that investment. When a business or investor uses leverage, they are essentially utilizing debt to fund a portion of their investment in order to increase their exposure to potential gains. The concept is rooted in the idea that by using borrowed money, the investor can keep more of their own capital invested, allowing for greater potential returns if the investment performs well.

This strategy becomes particularly effective when the return on the investment exceeds the cost of borrowing. However, while the potential for greater returns exists, it also comes with increased risk; if the investment does not perform as expected, losses can also be magnified because the borrower is still obligated to repay the loan regardless of the performance of the investment.

The other options do not capture the essence of financial leverage. Using equity to finance investments pertains more to ownership and shares rather than debt. Reducing expenses focuses on operational efficiency and profit management rather than how capital is structured. Investing in low-risk assets does not typically involve leverage, as it usually implies a conservative strategy that seeks stable returns without additional borrowing.