Rates are everywhere

A long time ago I wrote the first post about value investing. It's worth continuing because there are people interested

Before talking about cost, it is necessary to understand the concept of rates.

Let's start with the central bank rate for the EURO Currently the ECB rate is 4.5%

The simplest example of investment would be a bank deposit. The profitability of a deposit is determined by its rate, which is usually expressed as a percentage per annum. So a yield of 3% per annum means that for 100 euros invested in a year we can receive 3 euros of income and 100 euros from the deposit body.

For a bond, 5-6% will be acceptable - The risk premium is 0.5-1.5%, and is a kind of payment for the probability of not repaying the debt body; the longer the debt period before repayment, the higher the risk premium. The lower the borrower's creditworthiness, the higher the required premium that creditors ask for when placing a loan. The same ratio should be maintained when the key rate changes over time

For a corporate loan issued by a bank, let’s say 8%. This rate should be higher than the bond's yield, since the amount raised is often smaller, and on a market scale it is still a retail transaction compared to issuing corporate debt in a disproportionately larger volume. Between the deposit rate (3%) and the corporate debt rate (8%), there is a bank margin of 5% (in our example). At the same time, deposit obligations are usually short-term, while loans are issued for a long term. Therefore, the bank always has a systemic risk of changes in the cost of funding, which may not be in its favor. Because of this, floating rates are so popular, which allows banks to take a more flexible approach to probing and shift the risks of changes in the key rate to the borrower.

For a business that takes out this loan, the return will be 10%+ Why should the profitability of a business (as an asset) be higher than all previous rates? The main reason is risk. The size of the required return increases as the risk of bankruptcy and non-return of invested funds by shareholders increases. Particularly because shareholders are last in line to receive payments from existing assets after bankruptcy (customers, suppliers, and creditors come first). Also, the rate of return should be higher, since the business receives financing from banks or on the debt market to implement its projects and transactions. Taking on debt to conduct business is advisable only if it is possible to obtain a greater return on the borrowed funds.

So there is some picture of a balanced market by PROFITABILITY from the perspective of a value investor.

Next time we will talk about how the market is never balanced from this point of view.

I would like to point out that the information presented above is my point of view. It has been formed over many years of studying this area. These are not clippings from some educational materials. This is my perspective on value investing from an engineer's perspective. Thank you for your attention