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RAISING STANDARDS
Raising Standards of Cross-Border Cooperation
The FSD has launched an initiative to raise the standards of cross-border cooperation among securities regulators. FSD objectives are to protect investors, to ensure fair, efficient and transparent markets and to reduce systemic risk.
 
What we do ?

The Financial Services Department is established to promote investor confidence in the securities and capital markets by providing more structure and government oversight.

The mission of the Financial Services Department is to protect investors and maintain integrity of the securities industry, overseeing major participants in the industry, including stock exchanges, broker-dealers, investment advisors, mutual funds, and public utility holding companies.

Financial Services Department is concerned primarily with promoting disclosure of important information, enforcing securities laws, and protecting investors who interact with these various organizations and individuals

 
Borrowing to invest: Understanding Leverage
 

Borrowing to Invest: Understanding Leverage

We created this guide to help you understand how leverage is used in investing. It is intended as an overview of borrowing to invest. Before you invest with borrowed money, make sure you understand the risks of using a leverage strategy in your portfolio.

What is Leverage?

Leveraged investing is defined as borrowing money to finance an investment. You are familiar with the concept of leverage if you've ever:

  • Borrowed money to make additional contributions
  • Used a credit line for investing
  • Bought securities on margin from an investment dealer

  • Both individuals and companies use leverage as an investment strategy; a company with a lot of debt is considered highly leveraged. Leverage can be an effective way to boost returns in your investment portfolio, but you should also understand the potential consequences of borrowing to invest.

    Leverage magnifies your losses as well as your gains, and you must be able to withstand those losses if you are going to use borrowed money to invest. The leveraged investment should be suitable to your investment goals and objectives and consistent with the "know your client" information that you have provided to your dealer or adviser. It is both your responsibility and your adviser's to ensure that you understand the investment, and are comfortable with the risk level.

    Can You Handle the Risk? Is leverage right for you? Ask yourself these questions:

  • Do you understand the risks of borrowing to invest?
  • Can you afford to lose the collateral you pledged as security for the loan?
  • Do your leveraged investments fit your risk tolerance profile?
  • Are you able to comfortably pay back your loan?
  • What are the interest and repayment terms of your loan?
  • Are you monitoring interest rates and inflation? Do you understand their effects on your return?
  • How much money will you lose in your worst-case scenario? Can you afford it?
  • Are you aware of the tax consequences that apply to your investment?
  • Lesson #1: The Secured Investment Loan

    John Doe uses $50,000.00 from a bank line of credit to buy stocks. He secures the credit line using his home as collateral. This type of investment is a form of leverage, because John is using borrowed funds to finance his investment in stocks. John hopes that the value of his investment will increase to the point where he earns more from the investment than he is paying toward the interest on the line of credit.

    If John's investment decreases in value, he still has to make his monthly line of credit payment at the amount he originally negotiated. If John cannot make his monthly payment, he may have to sell the shares even if they have decreased in value. If the value of the shares does not cover the balance owing, he may be forced to sell his home.

    Any asset used as collateral, including your house, can be taken by your creditor to satisfy the debt.

    Lesson #2: The Mutual Fund Loan

    Larry has $75,000 saved for his retirement, which is five years away. Concerned that his savings will not support his lifestyle, Larry consults with a mutual fund salesperson. He tells Larry that a lender will match the amount of Larry's investment with a $75,000 loan, which he can use to invest in more mutual funds.

    According to the salesperson, Larry will easily be able to make the monthly interest payments on the loan by selling a small portion of the mutual funds each month. In this example we assume that fund companies allow 10% of holdings to be sold each year without triggering deferred sales charges.

    This strategy will only work if the value of the new mutual funds steadily increases. If the funds decrease, Larry will still have to make the interest payments on the borrowed money. Larry should also realize that the mutual fund salesperson receives a commission check for the initial sale of the funds, and may receive ongoing commission (trailer fees). Larry might also consider whether he wants to go into debt for an investment that can fluctuate in value, considering his approaching retirement.

    Investors should always be in a position to be able to pay for investment loans out of cash flow. Closely consider the fees associated with this type of investment. Many investors use leverage in this way to contribute more money and generate a higher tax refund. A common strategy is to use the tax refund to pay off or pay down the loan, decreasing the amount of interest payable.

    Buying on Margin

    When you buy securities on margin, you pay for a portion of the value of the securities purchased, and borrow the rest of the money from a registered investment dealer. Under federal securities laws, your investment dealer can only loan you a set of percentage of the value of your investment, known as the maximum loan value. The maximum loan value depends with the type of securities you are buying.

    What Are the Risks of Borrowing on Margin?

    If the value of your loan exceeds the allowed loan value, the dealer makes a margin call, requesting that you deposit more money into your account to protect the loan. If you cannot meet the margin call, the dealer can sell some or all of your investment, even at a loss, to make up the shortfall.

    In times of market decline, margin borrowing can be a quick way to lose money. While you can buy more securities using margin than you could without a loan, you could lose more than what you paid for the investment. You should be prepared to deposit more money on short notice, in order to meet margin requirements in a fluctuating market.

    Short Selling

    Short selling is a leveraging strategy that lets you take advantage of market declines. If you think the price of a security is going to drop, you can borrow shares of that security from your investment dealer and sell them at the current high price. If the share price falls, you can purchase the shares at the lower price on the open market and "return" the borrowed shares to your dealer. You profit by selling shares at the higher price, and buying at the lower price.

    What are the Risks of Short Selling?

    You are speculating that the security value will fall, so you can lose money if the value rises instead. Margin requirements for short selling are much higher than typical margin borrowing, because of the risk of using borrowed shares.

    When borrowing on margin, understand what your obligations are, and ensure that you can meet those obligations. If you cannot pay the interest or meet a margin call on your account, the investment dealer has the right to sell your securities, even at a loss. It is not a good idea to use short selling unless your cash flow can easily cover potential losses.

     
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    As an overseas financial services regulator you may seek information from Financial Services Department as part of your licensing or registration processes. Financial Services Department supports this regulator-to-regulator practice as part of our functions of monitoring and promoting market integrity and consumer protection in relation to the International financial system.
     
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    If you haven't found the information you need on our website or public registers you can make a probity request for confidential information. We release confidential information in accordance with our statutory obligations, which are outlined in Regulatory Guide 103.
     
    Overseas Regulator
    FSD's website can provide you with useful information that will assist you with your licensing or registration processes. You can access information contained in the public registers through our website. For example, you can confirm that a person or company holds an International financial services licence or is a banned and/or disqualified person.
     
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    FSD applies certain thresholds, to determine whether it is appropriate for us to respond to a probity check request.
     
     
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