<h2>Degree of Financial Leverage</h2>
<p>The <strong>degree of financial leverage</strong> is a measure of how much a company or an investor's equity will change in response to a change in the company's earnings or the value of an investment. It's a key risk indicator, widely used in finance and trading.</p>

<h2>How It Works</h2>
<p>The degree of financial leverage (DFL) is calculated as:</p>
<table>
<tbody>
<tr>
<td><strong>DFL</strong></td>
<td>=</td>
<td>Change in Equity</td>
<td>/</td>
<td>Change in Earnings</td>
</tr>
</tbody>
</table>
<p>Or, for investments:</p>
<table>
<tbody>
<tr>
<td><strong>DFL</strong></td>
<td>=</td>
<td>Change in Investment Value</td>
<td>/</td>
<td>Change in Underlying Asset Value</td>
</tr>
</tbody>
</table>
<p>For instance, if a company's equity increases by $100 for every $50 increase in earnings, the DFL is 2 (100/50).</p>

<h2>Why It Matters for Traders</h2>
<p>Understanding DFL is crucial for traders as it helps:</p>
<ul>
<li>Assess risk: Higher DFL means higher risk, as small changes in earnings or asset values can lead to significant changes in equity or investment value.</li>
<li>Compare investments: DFL allows traders to compare the riskiness of different investments or companies.</li>
<li>Make informed decisions: By knowing the DFL, traders can better anticipate how their investments might react to changes in market conditions.</li>
</ul>

<h2>Example</h2>
<p>Consider two companies, A and B, both with $100 million in equity. Company A has earnings of $50 million, while Company B has earnings of $20 million. If both companies' earnings increase by $10 million:</p>
<ul>
<li>Company A's new equity would be $120 million (100 + 100/5), so its DFL is 2.</li>
<li>Company B's new equity would be $140 million (100 + 200/20), so its DFL is 10.</li>
</ul>
<p>This shows that Company B is riskier, as its equity changes more for the same change in earnings.</p>

<h2>Key Takeaways</h2>
<ul>
<li>The degree of financial leverage (DFL) measures how much a company's equity or an investor's investment will change in response to a change in earnings or asset value.</li>
<li>DFL is calculated by dividing the change in equity (or investment value) by the change in earnings (or underlying asset value).</li>
<li>Traders use DFL to assess risk, compare investments, and make informed decisions.</li>
<li>Higher DFL means higher risk, as small changes can lead to significant changes in equity or investment value.</li>
</ul>