Risk and Return Flashcards
What is needed to calculate NPV?
A cost of capital
Major principle of risk and return?
Higher the risk faced by the ivnestor, the higher the return they will expect to be paid
Why are providers of debt finance relatively low risk?
Obligatory to make interest payments each year
Debt holders paid off before providers of share capital
When is debt especially low risk?
It is secured on a specific asset (fixed charge)
It is secured on general assets of a business (floating charge)
Due to be repaid in the short-term
Why is debt a relatively cheap source of finance?
Ruetnr expected by providers of debt is relatively low
Why is debt even cheaper to a taxpaying company?
Debt is also corporation tax deductible
Why do preference shareholders face higher risk?
As a dividend will only be paid if it can be afforded after providers of debt have been paid
Why do equity shareholders face highest risk?
As a dividend is only paid after providers of debt and preference shareholders have been paid
Why is equity a relatively expensive source of finance?
Debt holders and preference shareholders are paid before ordinary shareholders
Creditor hierarchy?
- Creditors with a fixed charge
- Creditors with a floating charge
- Unsecured creditors
- Preference shareholders
- Ordinary shareholders
What is the reverse yield gap?
Shareholders may be prepared to receive lower yields than lenders
