Analysis of Asset Allocation

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Financial Leverage : An introduction
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Leveraging a portfolio is dangerous. The purpose of this section is not to encourage you to borrow money but well to explain the leverage mechanisms.

DEFINITION

Leverage is the use of borrowed money to increase investing power.

The general idea is to give a portfolio as collateral (pledge) to a credit facility that will be used to increase the size of the portfolio.

Example: if the market value of your portfolio is USD 10,000.-, you can pledge your portfolio in favor of your credit institution to get a loan of USD 2,000.- to invest more in the security market.

Leverage technique can be used to get a loan but also to cover margin requirements on the derivatives market (cover future, short options,...).

We will see in the next sections the dangers of such a strategy but also the techniques used by the credit institutions to secure themselves of any losses and the use of advance ratios.


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