Question

In: Finance

Compare and contrast the risk and the return for debt and equity securities from the pespective...

Compare and contrast the risk and the return for debt and equity securities from the pespective of lenders/investors and issuers

Do not want to copy the answer directly from the Google. hope to be able to express clearly with own words. Thanks!

Solutions

Expert Solution

From the Investors' perspective:

Debt Securities Equity Securities
Risk Risk is lower for investors in debt securities compared to equity securities because investors in debt securities have first right on the cash flows & assets of the companies in case the issuing company defaults on repayments or goes bankrupt. For investors, Risk is higher in equity securities as the prices of equity securities fluctuate much more than equity securities so there is higher risk of losing capital. Also, dividends are not mandated by law for equity security holders so returns may or may not be there.
Return Debt securities generally provide lower but more consistent returns to investors. Diversified portfolios of equity securities have provided comparatively higher returns in the past over long time frames to investors. But it is important to note that there have been many short term instances where even best equity portfolios performed worse than debt securities.

Issuers' Perspective:

From issuer's perspectives, the situation just becomes reverse as described below:

Debt Securities Equity Securities
Risk Risk is higher for debt security issuers because repayment of debt is mandated by law. Failing to repay debt can push the issuer to bankruptcy. For issuers of equity, the risk is low because equity simply represents ownership in the company & thus there is no obligation of repayment.
Return The return is high because the cost of debt is usually less than the cost of equity for issuers. It gets further reduced due to the tax-shield effect thus enhancing the returns even more. Return on equity securities is lower for issuers because the cost of equity is much higher than the cost of debt as investors expect higher returns from equity.

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