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Explain how a conservative approach to financing a firms assets

Customer Question

Explain how a conservative approach to financing a firm’s assets is a low risk/low expected return strategy whereas an aggressive approach to financing is a high risk/high expected return strategy.
Submitted: 5 years ago.
Category: Finance
Expert:  George replied 5 years ago.

Using mortgage financing as an example. Let's say you need to finance your company with a mortgage. There are lots of mortgage options out there. You can lock in a 30 year fixed mortgage, which might cost you 6%. This is an example of low risk, low return because you could save money (thereby making money) by borrowing on a variable rate mortgage at, say, 2.5%, but it is high risk because it could go up much higher, let's say for discussion that it caps at 10%. you would be risking paying a higher rate later in order to make more money now, thereby high risk, high return.

 

Basically, the less risk you are willing to take on future costs, the more the lender is going to charge you because, on the other side of the transaction, he is giving up a potential higher return on his income (your interest payments) by locking you in on a fixed rate.

 

Hope this helps,

 

George

Expert:  George replied 5 years ago.

Also, you made a couple of computation errors. The overline is at .5%, which is .005. You should change your calc to .005 rather than .5. I believe it come to 1100.

 

Also the division is incorrect on the last line of your calc. Re check that. I believe your logical flow is correct if you make those changes.

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