The Daily Mail City Team explain leverage. What is it? A fancy word for debt - in particular, debt that helps to 'lever' your investment returns upward. Invest £200 of your own money in shares which rise 10% in a year, and your return is £20 or 10%. Borrow a further £200 in Japan at a 2% interest rate, invest £400, and your return is £40 minus £4 interest, or £36, which works out at 18% on your own money. Now you know how to set up a hedge fund. Why does it matter? The wheeze only works if interest rates stay low, currencies do not change much and you invest in something good enough to cover your borrowing costs. If not, the loan still has to be repaid and you are in trouble. Investment banks and hedge funds have borrowed massively around the world since central banks slashed interest rates after the 9/11 attacks. They poured the money into 'structured credit funds' which bought dodgy US mortgages. When the value of these collapsed, the funds became unsaleable, causing a global panic. What happpens next? More bankers sitting on toxic 'credit funds' will have to come clean. Massive City bonuses are dwindling visibly. Private equity firms can no longer borrow on such a heroic scale. At worst, it could trigger a bear market and a global slump.Leverage
31 August 2007, 9:33am
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