Various corporates reflect debt deflation risk as nominal bonds inflate the firm’s leverages unexpectedly depending on the interest rates of the currency. Business cycle encompasses various structures to avoid the risk through various sources of finance such as bond debt, common stock equity and preferred stock equity. The essay elaborates the how various risks affect international financial market capital and the effects that those risks impacts on the weighted average cost of capital (WACC).
Debt finance emanates from diverse sources such as financial institutions that offer credit to various firms in both short term and long term period depending on the contractual capacity to repay the loan. In addition, it may also be solicited from suppliers, retailer, families, and friends. However equity finance originates from private investors, government and venture capitalist to runs internal business affairs (Marks, et al., 2005). Preferred stock equity obtains dividends before common stock equity issuance depends on the nature of the business the company would acquire higher shares in each of the fiscal year earnings of a company.
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Bonds usually carry a fixed nominal face value in developed countries to fluctuate depending on the inflation and interest rates incurred. When real liabilities increase, the cash flow would decrease because of the default in risk especially among corporates that are at the nominal level of debt. Therefore the volatility of a firm would depend on the value of the corporate price of the bonds when spread. Therefore, inflation risks financial aspects in the international market thereby resulting in the spread of variation between bonds yielded freely and bonds from corporate yield (Marks, et al., 2005). However, inflation reduces the earnings of preferred stocks in financing entrepreneurs. Since the dividend earned at the end of the financial period would be lower as the ease of conducting business internationally would be expensive in currency exchange within the stock market. The ultimate result would be increased in debt deflation risks since more debts would accumulate rather than depending on profits for going concerns within the business entities.
Increased interest rates from bond debt affect the international financial market as increased credits would result in low realization of income profits and take more time repaying loans that expanding business ventures. Such economic condition would ultimately increase the probability of high inflation risks to avoid defaulting of the bond debt before the stipulated time elapses hence increased in liabilities of the lender (Pinto, et al., 2013). In addition, the correlation of cash flows and inflation are optimal the assets of the institution or nation would be sold at a throwaway price to salvage the loan acquired after the expiry of loan limit. Such defaulting on payment risks entities of becoming a liability instead of making profits making investors lose their credibility in their undertakings.
Since many startup companies prefer bond debt to finance their businesses, the expectation of higher credit cards forces them to make losses. Because of the changes in fiscal and monetary policies and ultimately resulting in higher premium since the marginal rate will not favor them and ultimately resulting in defaults. However, preferred equity stock and common stock are mainly embraced by small entrepreneurs (Pratt, 2009). They face challenges in repaying loan since most banks would change their lending rates when the interest rates are high resulting to small business entities to suffer loss especially because of monetary policies and low exchange rates within the international market. In equilibrium conditions, bonds are denoted in terms of nominal rate thereby reducing the inflation risk index as corporates realize premium liquidity substantially to their preferred equity stock.
Moreover, stagnation in a nation’s economic growth development index would result in low lending rates of bond debts, preferred and common equity stock since the lenders are a guarantee of defaulting risk. According to Loos (2007), such risks would lead to high-interest rates to the lenders that would make them incur liabilities at the expense of realization of the marginal cost of the benefit. For a firm to default payment, the level of debt would have aggregated the level of stocks and would ultimately be forced to pay to liquidate dividend from the common stock of equity.
The different interest rates associated with debt would result affect the weighted average cost of capital because of the firms in the ability to trade internationally in the financial market and reduction in stock level. Reduction in lending rates from creditors and bond debt forces the shareholders their capital cost to leverage the weighted average cost of capital hence they prefer common stock and preferred equity stock as their source of finance (Loos, 2007). Ultimately, when the company default payment because of a high inflation rate that results to increase interest rates, then the shareholder my miss their dividends from their total earnings. Such situation would precipitate the noncumulative conversion of shares to salvage the firm’s weighted average cost of capital in trading within the international market. Finally, preferred stock reduces the weighted average cost of capital in financial market internationally since commons stock is more expensive and bond debt hence occurring as unsecured debt and the organization may have a chance of replacing their preferred shares.
References
Marks, K. H., Robbins, L. E., Fernandez, G., & Funkhouser, J. P. (2005). The handbook of financing growth: Strategies and capital structure (Vol. 179). John Wiley & Sons.
Pinto, J., Robinson, T. R., Rath, R. D., & ASA, C. (2013). Equity valuation. CFA Institute.
Pratt, S. P. (2009). Business valuation discounts and premiums. John Wiley & Sons.
Loos, N. (2007). Value creation in leveraged buyouts: Analysis of factors driving private equity investment performance. Springer Science & Business Media.
