In financial terms, leverage is reinvesting debt in an effort to earn greater return than the cost of interest. When a firm uses a considerable proportion of debt to finance its investments, it is considered highly leveraged. In this situation, both gains and losses are amplified. Margin is a form of debt or borrowed money that is used to invest in other financial instruments. It is often used as collateral to the holder of a position in securities, options or futures contracts to cover the credit risk of his or her counterparty. The concept of leverage and margin are interconnected because you can use a margin to create leverage.

Leverage allows a firm to invest in assets that have the potential to generate high returns. Unfortunately, a leveraged firm brings about additional risk because if the investment does not provide the returns expected, the firm still has to pay back the debt and interest. When a firm is leveraged it ultimately means that it depends somewhat on debt to finance its investments. A leveraged firm does have its advantages, however. For example, it can increase shareholders' return on investment by giving the company the ability to take on more high return yielding projects and there is also a tax advantage that is related with borrowing.

A margin is collateral such as cash or securities that is deposited into an account to cover credit risk that the other investor must take on when they have a position in a security, option or futures contract. The margin account is used to cushion any losses that may occur from fluctuations in prices. It helps to decrease default risk because it constantly monitors and ensures that the investors are able to honor the contract. A margin is also considered borrowed money that is used to buy securities. This can be a practical way of obtaining funds in order to invest in a profitable investment.

A margin account allows you to borrow money from a broker for a fixed interest rate to purchase securities, options or futures contracts in the anticipation of receiving substantially high returns. Some stocks or securities are not permitted to be margined - this is usually due to their volatility and the desire of brokers to refrain from lending out money when there is a high potential for default. It is important when deciding to borrow money that a thorough investigation be done to make certain that the investment is reliable and not excessively risky. This is because an inability to pay back the principal and interest of a loan could result in bankruptcy.

For further reading, see The Advantages of SPAN Margin, How Does Your Margin Grow? and Getting Started in Foreign Exchange Futures.

  1. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  2. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  3. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  4. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  5. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  6. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>
Related Articles
  1. Chart Advisor

    4 European Stocks to Consider Buying

    European companies, listed on US exchanges, that are providing buying opportunities right now.
  2. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  3. Chart Advisor

    ChartAdvisor for October 2 2015

    Weekly technical summary of the major U.S. indexes.
  4. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  5. Investing

    Oil: Why Not to Put Faith in Forecasts

    West Texas Intermediate oil futures have recently made pronounced movements. What do they bode for the world market?
  6. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  7. Technical Indicators

    Why MACD Divergence Is an Unreliable Signal

    MACD divergence is a popular method for predicting reversals, but unfortunately it isn't very accurate. Learn the weaknesses of indicator divergence.
  8. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  9. Investing News

    6 Signs You Are Addicted To Investing

    An addiction to trading can ruin your life and relationships. Not to mention the monetary costs. There are telltale signs that you've gone too far.
  10. Economics

    Is the U.S. Economy Ready for Liftoff?

    The Fed continues to delay normalizing rates, citing inflation concerns and “global economic and financial developments” in explaining its rationale.
  1. Put-Call Parity

    A principle that defines the relationship between the price of ...
  2. Maturity

    The period of time for which a financial instrument remains outstanding. ...
  3. Employee Stock Option - ESO

    A stock option granted to specified employees of a company. ESOs ...
  4. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin ...
  5. Implied Volatility - IV

    The estimated volatility of a security's price.
  6. Plain Vanilla

    The most basic or standard version of a financial instrument, ...

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!