Financial leverage

INTRODUCTION:Financial Leverage is the extent or degree to which the company’s total capital is composed of Debt. You’ve probably heard the term before, leverage, but what exactly does it mean? Another term is gearing. So when you use this, you are also doing what can be called gearing. In essence means using the resources that are available to magnify the positive or negative aspect in the final product or result.Usually when you do this type of dealing in business or finance, it is similar or synonymous with borrowing. This greatly involves ROA (return on assets) and ROE (return on equity). The main point is to make ROE higher than the ROA. If it is not, leverage or borrowing can be used.1.2 Research ProblemThe study of leverage effect on Stock Return is crucial to understand the behavior of stock & Its Return that textile sector of Pakistan experience in their daily activities. Different companies selected for detailed analysis for the period 2008 to December 2011.1.3 Objective of StudyThe objective of this study is to critically examine the possible effects that a firm’s• To check the impact of leverage on stock return textile sector of Pakistan.• Textile Sectors have been selected for the purpose in Pakistan, the analysis of leverage effect would focus on them. The time period is spread over 5 years (2008 to 2012).

1. LITERATURE REVIEW:Hamada (1972) and Rubinstein (1973) demonstrate that a firm’s beta should increase if the firm finances more heavily with debt. These theories are extension of the pre-CAPM work of Modigliani and Miller (1969), who show that use of debt increases equity return variability. In his analysis of market risk, Hamada concludes that 21 percent to 24 percent of a firm’s systematic risk could be explained by the nature of its financing. Hamada (1972) and Rubinstein (1973) demonstrate that a firm’s beta should increase if the firm finances more heavily with debt.

2. METHODOLOGY3.1 DATA COLLECTION:Secondary data for the purpose has been collected from Karachi stock exchange, Annual reports, Finance books, Moreover some information was collected from different websites. The annual data of firms is taken from the various issues of “Balance Sheet Analysis” published by State Bank of Pakistan3.2 PROCEDURE:Annual reports of selected corporations have been collected from the industries and retrieved the required information. The stock prices of four years (2008, to 2011) of selected industries have been gathered from their websites. The total time of data collection was almost three to four weeks included only secondary data.

3.4 VARIABLE3.4.1 Dependant

The dependant variable in this research is stock return.3.4.2 Independent

The independent variable is leverage, current ratios, stock prices.

Financial leverage

CONCLUSION:

As the research has been conducted we found that other then Systematic Risk there are some factors which can also affect the return. We studied the CAPM model which has been criticized later on because of not considering some other variables which can also contribute in determining the stock return. Among those variables only leverage effect studied here. This research paper found that there is significantly positive effect of Leverage on stock return in High leverage portfolio and significantly negative effect in lower leverage portfolio, we concluded such differences which occur in various portfolio of Pakistani market because of inefficient market.

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