What does "financial leverage" refer to in investment terms?

In investment terms, financial leverage refers to the use of borrowed funds to increase the potential return on investment. When investors or companies utilize leverage, they aim to amplify their gains. For instance, if an investor borrows money to buy more assets than they could purchase outright, they can potentially achieve higher returns if those assets perform well. The idea is that the returns on the borrowed investments will exceed the cost of the debt, resulting in greater profits.

Using financial leverage can enhance returns not only on investments but also on equity because it allows for a larger base of assets to generate income. However, it's essential to understand that while financial leverage increases potential returns, it also introduces higher risk. If the investments do not perform as expected, the losses can also be magnified, and the obligation to repay borrowed funds remains. This duality of financial leverage makes it a critical consideration in investment strategies.

In contrast, the other options highlight different financial concepts but do not encapsulate the essence of financial leverage as it relates directly to the relationship between borrowed funds and potential returns.