The correct statements that describe how an investor can create the effect of leverage on his/her account are:
I) Buying equity of a levered firm: When an investor buys equity (stocks) of a levered firm, they are essentially investing in a company that has borrowed money to finance its operations or expansion. By buying equity in such a leveraged firm, the investor benefits from the potential magnified returns on their investment if the company performs well. However, there is also increased risk involved, as losses can also be magnified.
III) Borrowing on his/her own account: Another way an investor can create leverage is by borrowing funds on their own account. This means taking on debt personally to invest in various assets, such as stocks, real estate, or other investment opportunities. By borrowing money, the investor can amplify their potential returns if the investments perform well. However, it also increases the risk because losses can be magnified as well.
Investing in risk-free debt like T-bills (II) does not create leverage. Risk-free debt investments are typically considered safe and do not involve leverage. T-bills are low-risk investments issued by the government, and they provide a fixed return over a specified period without any amplification of returns or risk.
To summarize, both buying equity of a levered firm (I) and borrowing on his/her own account (III) can create the effect of leverage on an investor's account.
