What is a common characteristic of financial leverage?

Financial leverage is a strategy that involves borrowing funds to invest in assets, which can increase the potential return on investment. The key characteristic of financial leverage is that it amplifies both potential profits and risks. When an investor uses leverage, they increase their exposure to market movements; if the investment performs well, the gains are greater than if the investor had used only their own capital. Conversely, if the investment performs poorly, losses are also magnified compared to an unleveraged position.

This amplification occurs because leveraging involves taking on additional debt, which requires paying interest and potentially facing repayment obligations regardless of investment performance. As a result, if the asset's value declines, the investor's equity can be significantly impacted, highlighting the higher risk associated with leveraged positions.

In contrast, leveraging does not inherently carry low risk, it demands prior investment (in terms of initial equity or margin), and it does not guarantee fixed returns; rather, returns are variable and contingent on the performance of the underlying investments. This characteristic makes understanding financial leverage essential for managing investments effectively and for anticipating the associated risks.