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Guest KingCharles1st

Can Someone Please Explain The Term "leverage" Please- Ta Very Much.

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ta

Leverage, or gearing, works like this:

If you have 10k in cash, and want to invest in an asset, say housing, you might use it as a deposit, but borrow a higher amount, say 90k, so as to purchase a 100k house. Hence you have leveraged (or geared) your investment: you now have 100k at stake rather than 10k.

In a rising market this means that you're making more profit e.g. if prices double you now have 200k (and a loan of 90k).

In a falling market the reverse happens e.g. if prices halve you now owe 90k on an asset worth 50k

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ta

leverage a.k.a gearing

say you buy a house for £100K, you put in £10K, borrow £90K

House price increases by 10%, now worth £110K.

You sell house and pay off debt, you are left with £20K.

Although the price of the house has increased by only 10%, leverage or gearing means your stake has increased by 100%, so you have 10x leverage.

(Now consider price falls ;))

JY

(written before I saw casual observers post: spooky)

Edited by JustYield

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leverage a.k.a gearing

say you buy a house for £100K, you put in £10K, borrow £90K

House price increases by 10%, now worth £110K.

You sell house and pay off debt, you are left with £20K.

Although the price of the house has increased by only 10%, leverage or gearing means your stake has increased by 100%, so you have 10x leverage.

(Now consider price falls ;))

JY

(written before I saw casual observers post: spooky)

That IS a bit spooky, we even used the same amounts!

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EDIT: And note the potential for massive loss. Granite drops to nothing. I lose my £10 and still owe £9,990 with no way of paying.

As you know that's why God created options, you can still wave goodbye to your premium though.

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Easiest way to think of leverage or 'gearing' is to look at the financing of a company which can be all debt, all equity, or some combination of the two. As the underlying value of the business changes so the value of the equity changes but not the debt which is fixed.

In a company with low gearing (say 90% equity:10% debt) the shareholders are pretty well exposed to the fortunes of the company. If the underlying value of the business doubles they are rewarded via by a near-doubling of the value of the equity [190/90 = app. 2] in line with the true improvement in the business. Likewise, if profits fall or losses are made they bear most of the decrease in value.

In a highly geared company (say 10% equity: 90% debt) then a doubling in the underlying asset value means that the equity increases in value tenfold [110/10 = app. 10]. Equally, however, if it halves then the company is no longer solvent (the debt is worth more than the company) and so the equity is worthless. Eurotunnel is close to this position. The shareholders are using debt to leverage or gear their investment. It is more of a gamble - and arguably with other peoples' money (although no-one forces banks to lend).

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Guest KingCharles1st
Easiest way to think of leverage or 'gearing' is to look at the financing of a company which can be all debt, all equity, or some combination of the two. As the underlying value of the business changes so the value of the equity changes but not the debt which is fixed.

In a company with low gearing (say 90% equity:10% debt) the shareholders are pretty well exposed to the fortunes of the company. If the underlying value of the business doubles they are rewarded via by a near-doubling of the value of the equity [190/90 = app. 2] in line with the true improvement in the business. Likewise, if profits fall or losses are made they bear most of the decrease in value.

In a highly geared company (say 10% equity: 90% debt) then a doubling in the underlying asset value means that the equity increases in value tenfold [110/10 = app. 10]. Equally, however, if it halves then the company is no longer solvent (the debt is worth more than the company) and so the equity is worthless. Eurotunnel is close to this position. The shareholders are using debt to leverage or gear their investment. It is more of a gamble - and arguably with other peoples' money (although no-one forces banks to lend).

Thanks guys!

I pretty much understand what you are saying.

So therefore it is ok (teriffic) to have HIGH gearing in a high yield business, as long as you pull the plug and cash in your chips way before anybody but you smells a rat on the horizon..? :rolleyes:

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Thanks guys!

I pretty much understand what you are saying.

So therefore it is ok (teriffic) to have HIGH gearing in a high yield business, as long as you pull the plug and cash in your chips way before anybody but you smells a rat on the horizon..? :rolleyes:

That's true, but you need to balance risk with reward.

Don't bet with money you can't afford to lose.

That's one of the key problems with the current housing boom. Many people who have bought to let only see the upside. If you own houses outright, you will not be ruined by a housing crash. However, those who have borrowed heavily to fund their investments could find themselves turned from property millionaires into bankrupts.

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Thanks guys!

I pretty much understand what you are saying.

So therefore it is ok (teriffic) to have HIGH gearing in a high yield business, as long as you pull the plug and cash in your chips way before anybody but you smells a rat on the horizon..? :rolleyes:

The trouble with gearing is that it increases volatility.

With low gearing comes low volatility, as we had in the mid nineties.

If your deposit is 25% you are limiting your upside, but it's safer.

Price movements are more subdued.

Now with prices so high, people who buy are committed to high gearing (say 90%+), and prices can jump very quickly, as we have seen.

But similarly smaller price falls will cause greater losses.

Hence the bigger the boom, the bigger the bust.

It's a force of nature, nothing Gordon Brown can change.

He may as well change gravity.

And people are seriously over-geared in this property market.

That's one of the reasons I think the "different this time" argument is such complete and utter rubbish.

Edited by BandWagon

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I have a simple rule.

I dont borrow money to buy a depreciating asset.

But almost everybody does it with cars.

Now people are doing it with houses, but they don't know it yet, by the time they find out it will be to late to get out, and boy it's gonna hurt.

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Since you mention it, quote from the front page of today's FT:

As Warren Buffet once said, when you combine ignorance with leverage you get some pretty interesting results (John Plender)

One of you lot might want that for your footer thingy.

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  • 338 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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