Question

How do you think of this paragraph. Please, give some suggestion.

Investors will evaluate borrowers' risk by knowing borrowers' incomes or ability of paying back to them. For example, if some companies want to borrow money from banks or the public, then they need to pay higher interest return rate to lead investors trust them. Since, compare to the U.S Treasury, which is regarded as risk-free, there are higher potential risks if investors invest their money to other companies. Thus, investors will consider the opportunity cost of capital, whether it is worth for them taking risk and lending money to borrowers if they can get higher return. Higher risk will provide higher return to investors if borrowers can guarantee to pay money back to investors.

Answer 1

It appears to be a paragraph regarding risk associated with lending money.

Investors will evaluate the borrower's risk by asertaining its profitability and cash flow stream. They will be keen on knowing the borrower's ability to repay the loan.

The interest rate on amount borrowed will depend on a number of factors such as borrowing capcity of borrower, duration of amount borrowed, security offered by borrower's, etc.

Now, suppose if the goverment wants to borrow money, they can issue U.S. Treasury. Since, the tenure is small and default chance is very low, it is regarded as risk-free and will carry minumum interest. If we wants to borrow money, the rate will obviously increase as uncertainity regarding the repayment of funds arrises. As and when the risk increase, the rate of borrowing starts to go up, compensating for the additional risk.

So, if the investor wants to earn higher return, he need to find a risker borrower who will be willing to pay more than the risk-free rate compensating the investor for risk assumed by them.

Investor should be cautious of not selecting too risky borrowers as they can default the interest or principal and make investor lose their money. Investor should evaluate borrower's repayment capacity and opportunity cost of capital before investing.

Also, we can say, higher the risk, higher the return.