What effect does leverage have on investments?

Leverage refers to the use of borrowed funds to increase the potential return on investment. When a company or individual uses leverage, they can invest more capital than they currently possess, which can magnify both the potential gains and the risk of losses.

Utilizing leverage can amplify returns when investments perform well because the profits are generated on a larger base of assets. However, if the investments do not perform as anticipated, losses can also be magnified, thus increasing the risk for the investor. Therefore, leveraging can lead to higher potential returns alongside higher risks, illustrating the dual-edged nature of using borrowed money in investments.

This understanding of leverage is crucial for investors and companies alike, as it highlights the need for careful risk management and assessment when deciding to take on debt for investment purposes. The correct response underscores the critical importance of acknowledging the balanced relationship between increased potential returns and risk when leveraging investments.