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What form of invested capital is subject to most of the firm's business and financial risk?
Equity capital
What types of risk does the granting of credit entail?
The risk of lending on character is called "moral risk." The risk of lending on capacity is called "business risk." The risk of lending on capital is called "property risk."
How do market rates and the company's perceived market risk impact its cost of capital?
How does the capital market affect corporate governance?
Why has the trend in bank supervision moved away from a focus on capital requirements to a focus on risk management?
Since capital requirements do not effectively indicate whether banks are taking on too much risk, risk management allows supervisors to focus more on risk-taking procedures and thus may prevent insolvency in the future.
What risks are associated with granting credit?
The risk of lending on character is called "moral risk," the risk of lending on capacity is called "business risk," and the risk of lending on capital is called "property risk." An ideal borrower will combine a minimum of each of these three risks
Why does causes cost of capital increase?
element of risk is the factor which causes the cost of capital to increase as much the risk as much the cost of capital.
Suppose a firm estimates its cost of capital for the coming year to be 10 What are the reasonable cost of capital for an average risk project high risk and low risk?
In order to determine reasonable costs of capital for average, high and low risk projects the firm should develop risk-adjusted costs of capital for each category of risk based on the concept of divisional WACC. If a firm estimates that its cost of capital for the coming year will be 10%, the firm should use 10% as the basis for its average risk projects since the firm will need to achieve a minimum of a 10% return on all its projects. Typically, a high-risk project has the potential for higher returns and a low-risk project will typically yield lower returns. Therefore, the firm could set the cost of capital for its high-risk projects at 12% and the cost of capital for low risk projects at 8%. Since the average risk project has a 10% cost of capital, the overall risk of the firms projects will be equal to the 10% cost of capital. Similarly, if the firm's high-risk projects are particularly risky, they could be set at a 15% cost of capital and the low-risk projects will be adjusted down to a 5% cost of capital. The ultimate goal is that the portfolio of the firm's projects will achieve the required 10% return or greater so that the cost of capital to fund the projects is covered. The assignment of risk is somewhat subjective but it is better than not adjusting the risk at all.
What is Risk adjusted return on economic capital?
RAROC is a risk based profitability measurement for analyzing the risk-adjusted financial performance of the company and for providing a consistent view of the profitability across businesses. RAROC is usually used in banking parlance where companies have to handle the risk of losses.In business enterprises, risk is traded off against benefits. RAROC is defined as the ratio of risk adjusted return to economic capital. The economic capital is the amount of money which is required to secure the survival of the organization in a worst case scenario; it is a buffer against expected shocks in the market values. Economic capital is a function of credit risk, market risk and operational risk and is often calculated by VaR (Value at Risk). This use of capital based on risk improves the capital allocation across the different functional areas of banks, insurance companies or any other business in which capital is placed at risk for an expected return above the risk-free rate.Formula:RAROC = Expected Return / Economic Capital orRAROC = Expected Return / Value at Risk
How Capital Adequacy Ratio of a Bank is arrived?
The Capital Adequacy Ratio of a bank is arrived at by comparing the sum of its Tier 1 and Tier 2 capital to its risk. The equation for expressing the Capital adequacy ratio is: CAR=(Tier 1 Capital +Tier2 Capital)/Risk weighted assets.
Which of the following is the most relevant measure of risk for capital budgeting purposes?
Market risk is theoretically the most relevant measure of risk for capital budgeting purposes because it is reflected in stock prices.
What are the disadvantages of share capital?
Disadvantage of share capital is that it increases the risk of default which causes the increase in cost of capital.
What form of invested capital is subject to most of the firm's business and financial risk?
Equity capital
What types of risk does the granting of credit entail?
The risk of lending on character is called "moral risk." The risk of lending on capacity is called "business risk." The risk of lending on capital is called "property risk."
How can venture capital be invested?
Venture capital is invested in early-stage, high-risk startup companies.
Who are people that risk capital in order to organize and a business?
entrepreneurs
Why Cost of preference capital is lower than cost of equity capital?
It depends on level of risk involved with certain type of capital, as low the risk factor as lower the cost or interest. That same formula applies to government securities as well.
What is the lowest risk in terms of capital budgeting?
adding to a product line.
