What is Borrowed Capital?

borrowed capitalBorrowed capital consists of funds borrowed from either individuals or institutions. Borrowed capital can be used in a number of ways. Investors use borrowed capital to increase their potential investment returns; this use is known as leverage. The upside of investing with borrowed capital is the potential for greater percentage gains; the downside is the potential loss of someone else’s money, which must then be repaid. Another way borrowed capital can be used is by businesses as a loan or debenture. (Also referred to as loan capital).

Investors commonly use borrowed capital when trading in the forex markets. Critics consider this leveraged trading to be dangerous, while proponents argue that with the proper precautions, such as the placing of stops, investors can achieve their goals faster without taking on too much risk.

Borrowed capital is also used as real estate finance, ie a mortgage, to buy a home. In this case, the purpose of borrowing capital is not necessarily to improve potential investment returns, but to make it possible to purchase an expensive asset that is difficult to pay for in one lump sum.

Net Borrower

A net borrower is an entity that borrows more than it saves or lends out. A net borrower could be a company, country, government, group or individual. Borrowing can take the form of debt by acquiring goods and/or services under the stipulation of future payments, borrowing funds, or by issuing debt, such as bonds. Net borrowing occurs when the monetary summation of these borrowing activities exceeds the monetary amount of funds and assets lent/saved. (Also known as net debtor).

A country is a net borrower when it is running a deficit and is also known as a capital importing country. For example, a country might acquire capital by selling debt instruments such as bonds to international investors or to its own residents.

This is not considered good or bad for a country. If a country has a capital inflow then the international community feels it’s a safe place to invest. Also capital inflows potentially allows for future levels of productivity that would otherwise be unattainable.

Net borrowers will be worse off when interest rates go up if their borrowing rates are not fixed.

Leverage

Leverage is the investment strategy of using borrowed money: specifically, the use of various financial instruments or borrowed capital to increase the potential return of an investment. Leverage can also refer to the amount of debt used to finance assets. When one refers to something (a company, a property or an investment) as highly leveraged, it means that item has more debt than equity.

How Does Leverage Work?

At automobile dealerships, a significant number of car shoppers leave the lot with a brand new car, even though they could not afford to pay for that car in cash. To obtain the car, these buyers borrowed the money. They then gave the borrowed money to the car dealer in exchange for the vehicle.

The Difference Between Leverage and Margin

Although interconnected, since both involve borrowing, leverage and margin are not the same. Leverage refers to the act of taking on debt. Margin is a form of debt or borrowed money that is used to invest in other financial instruments. A margin account allows you to borrow money from a broker for a fixed interest rate to purchase securities, options or futures contracts in the anticipation of receiving substantially high returns. In short, you can use margin to create leverage.

 


 

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