What does "leverage" refer to in finance?

Leverage in finance specifically refers to the use of debt to amplify potential returns on investment. This concept is based on the principle that by borrowing funds, a company or investor can increase the total amount of capital available for investment. When investments yield a return that exceeds the cost of the debt (such as interest payments), the additional profits gained from using borrowed funds can generate a higher return on equity.

By utilizing leverage, investors can pursue larger projects or investments than they could with just their own equity. However, while leverage can significantly boost returns when business performance is strong, it also increases financial risk, as the obligation to repay debt remains regardless of investment performance.

The other options do not accurately capture the financial concept of leverage. The use of equity to reduce taxation focuses on tax strategies rather than the mechanics of leveraging debt. Utilizing personal savings for investment deals with personal finance choices rather than corporate or investment leverage. Investing in low-risk bonds does not involve leveraging debt for higher investment returns and thus does not reflect the essential characteristic of leverage in finance.