Professional Documents
Culture Documents
4th edition
Dr Ruth Bender
Chapter 11
Learning objectives
Risk and return
The risk-averse investor
The speculative investor
The building blocks of financial instruments
Characteristics of debt and equity
Rules for designing a financial instrument
Risk profile determines yield and gain to investor
Caps, floors, and collars
Net flows from swapping floating rate into fixed
Required
return
Perceived risk
Risk-averse
investor
Required
return
Market line
Perceived risk
Required
return
Market line
Speculative
investor
Perceived risk
Risk v Return
Downside protection Yield
Repayment Fixed / Floating / Other
Security Discretionary or by right?
Guarantees Upside
Sale / Redemption /
Covenants
Exchange?
Voting rights
Depends on markets or on
Veto rights the company?
Board representation Guaranteed? Discretionary?
Perks
Debt Equity
Risk to the investor Low, protected by High
security and
covenants
Yield Interest, normally Dividends, at the
contractually agreed discretion of the
directors
Potential upside to None Very high
the investor
100%
Proportion of
required
return 100% 100%
supplied by yield gain
yield
0%
Perceived risk
cap
collar
floor
Lender
Floating rate interest
payments
Loan &
repayments