What does financial leverage refer to?

Financial leverage specifically refers to the practice of utilizing borrowed funds to increase the potential return on investment. By borrowing capital, an investor can invest more than they could using just their own funds. This strategy magnifies both the potential gains and losses associated with an investment.

When leveraging, if the investments yield a return greater than the cost of borrowing (such as interest payments), the overall return on equity can significantly increase. This positive effect occurs because the investor is able to control a larger amount of assets than they could without borrowing. However, it's important to note that while leverage can enhance returns, it also increases the risk of losses if the investments do not perform as expected.

The other options do not capture the essence of financial leverage. Using personal funds for investments indicates an equity financing approach without debt, while avoiding borrowed capital means steering clear of leverage altogether. Investing in low-risk assets does not specifically involve leverage and typically reflects a conservative investment strategy rather than one aimed at maximizing returns through borrowed funds.