General Securities Representative (Series 7) Practice Exam – Your All-in-One Guide to Exam Success!

The primary advantage of financial leverage lies in its ability to significantly amplify returns on equity investments. When an investor uses borrowed funds to increase the amount of money they can invest, they can potentially earn a higher return on their equity than they would have achieved by investing only their own capital. This effect occurs because the returns generated from the total investment are compared against a smaller amount of equity, thereby increasing the percentage return on that equity if the investment performs well.

For example, if an investor uses leverage to purchase an asset that appreciates in value, the gains are realized on the total investment while the cost of borrowing remains fixed. Therefore, if the asset's value increases, the investor benefits from a higher return relative to the original equity investment, thereby enhancing their overall profitability.

Financial leverage, however, does also come with increased risk since it magnifies losses in the event the investment underperforms or the value of the asset decreases. The risks associated with leverage are important to consider, as they can lead to financial difficulties if not managed correctly, but the primary advantage nonetheless is the enhancement of returns on equity.