Learn something new every day
More Info... by email
Trading on the equity has to do with making use of borrowed funds to increase or expand the investment of capital. The hope is that by following this pattern, the return that is realized on the trading will ultimately cover any finance charges associated with borrowing funds for an investment will be offset and a profit still realized. Trading on the equity is not an unusual means of leveraging finances in order to position a company to take advantage of emerging markets or opportunities to expand the company’s presence in an existing market.
As with just about any type of financial investment, going with a trading on the equity approach does carry some degree of risk. For this reason, companies tend to take the task of borrowing funds very seriously. There is often a great deal of research done in advance of making the decision to expand the level of capital investment through this strategy.
One key factor in deciding to employ trading on the equity has to do with projections of when and how much return can be reasonably expected from the expansion project. Ideally, the project has an excellent chance of generating revenue shortly after implementation. When this is the case, it is often possible for the project to begin covering the interest charges associated with borrowing the capital shortly after the launch. As months go by, the revenue generated by the project assumes a larger role in repaying the principle of the debt as well as covering the interest. At some point, the goal is to have the generated revenue exceed both the applicable interest charges and the principle amount borrowed, making the capital project truly profitable for the company.
Unfortunately, not every trading on the equity effort follows this pattern. Many factors may delay or even prevent the project from ever reaching its full potential. This can include such factors as changes in public tastes, shifts in the economy that make the project lose viability, natural disasters, and devaluation of currency on the foreign exchange market.
When a project funded by trading on the equity appears to be failing, the investor has a couple of options open. One is to abandon the project before any more resources are lost in the effort. While this does nothing to pay off the capital borrowed as part of the strategy, it does allow the investor to cease losing money and begin to apply available resources to pay off the outstanding debt. A second option is to take on a partner who is sees potential in the project and is willing to make a long term investment in the hope that the project will ultimately become profitable once the current economic situation changes.