What does leverage refer to in financial terms?

Leverage in financial terms refers to the use of borrowed capital to amplify potential returns on an investment. When investors use leverage, they essentially take on debt to increase the amount of capital they can invest. This can lead to higher profits if the investment performs well, as the returns are calculated on the total amount invested, including both borrowed and owned capital.

For example, if an investor uses leverage to purchase more shares of a stock than they could have with just their own funds, any increase in the value of that stock will yield a proportionally larger gain compared to their original investment. However, it is also important to recognize that leverage increases risk; if an investment loses value, the losses are also magnified.

In contrast, the other options do not accurately define leverage. The use of equity investments pertains to direct ownership and does not involve borrowing. Decreasing financial risks involves risk management strategies rather than leveraging debt. Managing operational costs relates to the efficiency of operational processes and is unrelated to the concept of leverage in finance.