Question

How do short sales and leverage work, and how do they affect the returns, strategies, and risks inherent in a portfolio?

Answer 1

Short sales is always helpful in creating high rate of return, because the investor who are not owning the stock can sell the stock by taking them on leverage and if the stock is moving as per their expectation on the way downside, there will be making returns on their desired position.

The gains on the short sales, should always be trying to beat the rate of of interest on the borrowings, so that the gains on short sales should be higher than interest on leverage so that will help in maximizing the return.

it will help the investor in order to hedge the portfolio also because he can be holding a portfolio and similarly he can short the stocks to hedge himself from any adverse economic scenarios and this will affect the strategy of the investor also because it will limit the overall return making capability.

It also helps in minimization of risk because it is used for elimination of risk by hedging by creation of opposite positions.