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David Nadig: The Complexities of Modern Markets - [Making Markets, EP.43]
Making Markets
Examining the Rise of Leverage in Financial Markets
The increase in leverage within financial markets can be attributed to a growing enthusiasm for free leverage among various types of investors, particularly in retail and advised segments. Despite interest rate fluctuations, this appetite remains strong. The ETF market is seeing a surge in leveraged single stock ETFs, which allow investors to amplify their exposure to specific stocks such as Apple and Tesla. These products are particularly appealing to day traders. However, the operation of these leveraged ETFs involves complex mechanics, as they engage in swap agreements with major financial institutions like UBS or Goldman Sachs, effectively transforming a $1 investment into $2.50 in exposure. This daily resetting of leverage requires institutions to adjust their positions in response to market movements, leading to a cycle of pro-cyclical trading that exacerbates market volatility as they are forced to buy more during price increases and sell during declines.
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