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Gearing w.r.t derivatives

N

nish44

Member
Hello

I have a question if anyone can help.

What does "gearing" mean with respect to derivatives. In CT2 we learned that gearing is the level of borrowing in a company. However, I'm sure there is a different meaning here.

In Chapter 22 (Portfolio Management 3) it says:

(i) An investment manager ..... can use the highly geared nature of futures to enhance returns

(ii) ..... buying calls gives a high level of gearing and low dealing costs.

Can anyone explain?

Cheers
 
gearing

When a company has a lot of gearing its equity shares are very exposed to changes in profitability (because there is a big fixed charge in the profit and loss). The same concept is referred to loosely as being "geared" to something. When you buy a future you place only a small amount of money in a margin account, but you have a huge exposure to the underlying asset. Hence futures offer a geared exposure to the underlying asset.

Likewise options require only a small investment but give a large exposure to the underlying. This all relates loosely to the concept of a highly geared company. Hope this helps
 
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