Trading on Equity policy and its Limitation

Trading on Equity policy and its Limitation


Meaning

* It refers to practice of using borrowed money at fixed interest rates.

*It means taking advantages of ownership ( Here ownership means equity {capital} ) .

* It is the financial process of using debt to produce gain for the residual owner .

* Firm should earn return greater than the interest cost of the debt .

* In finance , equity tading is the buying and selling of company stock .


Limitation Of Trading On Equity

1 > FIxed Obligations

* company have to pay dividend and interest on debentures or fixed dividend        on preference shares .

Example -- If profit is 1000 in investment of 10000 which have interest 10% every year so , no amount is left for distribution among shareholder therefore whole profit is utilised for interest payment .

2 > Earning fluctuations

* Company gaining from trading on equity should greater than fixed charges .

* Firm should ready for future fluctuations .

* If profit is less than expected so , company should able to pay fixed charges .

3 > Diminishing Return

* There is a competitive capital market .

* More borrowing means rais in rate of interest .

* This means that further borrowing will be more and more costly .

4 > Huge fixed asset investment

* Company have to make a huge investment in fixed assets just to make its creditors ( the lenders of fund ) feel safe and secure .

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