Some basic finance
There are a number of finance products on the market. Essentially all option boil down to the same thing.
- The borrower borrows.
- The lender lends.
Some factors which will determine the lending rate to consider are:
Can the borrower post an asset as collateral. If so, then with this security, the lender can offer a lower rate (as the loss severity is essentially lower).
Good forms of security may be property, receivables or hard assets. There are also other forms that are harder to recover from a lenders perspective, such as personal guarantees, but they do indicate an additional levels of confidence. Naturally, the better (more valuable) the security, the lower the rate.
How many layers of people need to get paid before the borrower actually receives cash from the lender.
The more people (and other costs) that are involved, means that ultimately both the lender and the borrower are inclined to suffer. The lender will get a lower rate and the borrower will pay more.
Sometimes these are necessary and other times a burden. For example an introducing broker, how much will this entity charge ? or regulatory fees – how much does this increase the lenders costs as a percentage of a single loan.
The most optimal loan comes about when a natural lender (the ultimate source of funds) meets a natural borrower. At this point a close to pure market rate is agreed without frictional costs, such as hefty arrangement fees.
A good operating history gives lender added confidence. This in itself will not be satisfactory unless it can be established that this is set to continue (or even increase). For example, a company operating well in a bull market will have a good track record, but how will the same company perform in a downturn. Will the product retain it’s demand and margins to a sufficient level such that it will be able to continue to operate over any market instability ?
This is the clearing rate for risk with all of the above ultimately added (or subtracted). If the market is in a risk off scenario then the lender will demand higher returns, likewise in risk on markets, the borrower can pay less for an equal risk transaction. This is the natural supply and demand of the market and is dictated to both the borrower and lender by the broader market.