What do you understand by the term 'trading on equity'? (2024)

FAQs

What do you understand by the term 'trading on equity'? ›

Trading on equity means the use of fixed cost sources of finance such as preference shares, debentures and long-term loans in the capital structure, to increase the return on equity shares. This is also known as financial leverage.

Trading on equity is a financial strategy that allows companies to potentially amplify their returns by using borrowed funds to finance investments. While it can lead to increased profits and higher returns for shareholders, it may also come with greater financial risk.

Equity trading is the buying and selling of company shares or stocks, also known as equities, on the financial market. There are a few ways in which you can invest in equities. Most equity trading refers to the buying and selling of public company shares through a stock exchange or as over-the-counter products.

Exchange-traded equities

Famous examples include the New York Stock Exchange (NYSE) and London Stock Exchange (LSE). Companies start as private, meaning ownership is only held by a few individuals – often the founders, employees and venture capitalists.

The two conditions necessary for trading on equity are the availability of debt and the ability to generate higher returns on investments than the cost of the debt.

Trading on equity can also be termed as financial leverage. We can conclude that a company uses the equity strength to get the debts from the creditors.

If your car is worth more than you owe on it, then you have positive equity and can use that money toward the purchase of your new car. If you owe more than your car is worth, then you'll have to make up the difference with the dealer. It's also possible to trade in a leased car before your lease has come to an end.

An equity share, normally known as ordinary share is a part ownership where each member is a fractional owner and initiates the maximum entrepreneurial liability related to a trading concern. These types of shareholders in any organization possess the right to vote.

Equity can have multiple meanings, but at its core means ownership, or more specifically, the value of an ownership stake in an asset or company. Some of the most recognizable forms of equity are ownership in a company or your home's value after subtracting your mortgage balance.

Equity includes stocks as well as other tangible assets excluding debt. While it's possible to trade stocks, not all equities can be traded. In other words, equity is generally not freely tradable in the market since it directly affects the holding of a business entity but stocks can be traded in the market.

What is a good example of equity? ›

Equality on the other hand, means everyone is treated the same exact way, regardless of a person's needs or other individual differences. For example, in equity, the coach takes into consideration the specific needs of each player's position on the team, and provides the shoes they need to be successful.

Equities in trading are portions of ownership in a public-listed company. Equity is bought and sold in the form of shares or stocks, which are issued by companies as a way to raise money. When you buy equity, you are taking ownership of a small portion of that company.

Trading on equity is also called financial leverage. Both these terms signify that a corporate body leverages its financial standing to procure debt and enhance the earnings of shareholders. In other words, a company utilises its equity strength to avail debts from creditors, and thus the name of the strategy.

Trading on equity happens when a company incurs new debt using bonds, loans, bonds or preferred stock. The company then uses these funds to gain assets which will create returns which are larger than the interest of the new debt. Alternatively, trading on equity called financial leverage.

Since trading on equity is a debt, its interest will gradually rise. This means that trading on equity brings with itself a higher risk. People who invest in the company will want a reward for this increased risk. As a result, the company will have to decide to reduce the dividend rate of the shareholders.

Equity trading is not entirely safe as it involves risks. However, diversifying your portfolio and investing long-term can minimize the chances of equity trading. Doing your research, understanding the market, and consulting with a financial advisor before investing in equity trading are essential.

For all but advanced investors, stocks are probably the better choice than options at all times, but an easier way to buy them is through stock ETFs. You'll get diversified exposure to a stock portfolio, reduced risk and the potential for nice returns.