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Capital Allocation Line (CAL) and Optimal Portfolio

A graph depicting the risk-and-reward profile of risky assets

Written by

Tim Vipond

Published March 26, 2023

Updated June 28, 2023

Capital Allocation Line (CAL) and Optimal Portfolio

The Capital Allocation Line (CAL) is a line that graphically depicts the risk-and-reward profile of assets, and can be used to find the optimal portfolio. The process to construct the CAL for a collection of portfolios is described below.

Portfolio expected return and variance

For the sake of simplicity, we will construct a portfolio with only two risky assets.

The portfolio’s expected return is a weighted average of its individual assets’ expected returns, and is calculated as:

E(Rp) = w1E(R1) + w2E(R2)

Where w1, w2 are the respective weights for the two assets, and E(R1), E(R2) are the respective expected returns.

Levels of variance translate directly with levels of risk; higher variance means higher levels of risk and vice versa. The variance of a portfolio is not just the weighted average of the variance of individual assets but also depends on the covariance and correlation of the two assets. The formula for portfolio variance is given as:

Var(Rp) = w21Var(R1) + w22Var(R2) + 2w1w2Cov(R1, R2)

Where Cov(R1, R2) represents the covariance of the two asset returns. Alternatively, the formula can be written as:

σ2p = w21σ21 + w22σ22 + 2ρ(R1, R2) w1w2σ1σ2, using ρ(R1, R2), the correlation of R1 and R2.

The conversion between correlation and covariance is given as: ρ(R1, R2) = Cov(R1, R2)/ σ1σ2.

The variance of portfolio return is greater when the covariance of the two assets is positive, and less when negative. Since variance represents risk, the portfolio risk is lower when its asset components possess negative covariance. Diversification is a technique that minimizes portfolio risk by investing in assets with negative covariance.

In practice, we do not know the returns and standard deviations of individual assets, but we can estimate these values based on these assets’ historical values.

The efficient frontier

A portfolio frontier is a graph that maps out all possible portfolios with different asset weight combinations, with levels of portfolio standard deviation graphed on the x-axis and portfolio expected return on the y-axis.

To construct a portfolio frontier, we first assign values for E(R1), E(R2), stdev(R1), stdev(R2), and ρ(R1, R2). Using the above formulas, we then calculate the portfolio expected return and variance for each possible asset weight combinations (w2=1-w1). This process can be done easily in Microsoft Excel, as shown in the example below:

We then use the scatter chart with smooth lines to plot the portfolio’s expected return and standard deviation. The result is shown on the graph below, where each dot on the plot represents a portfolio constructed under an asset weight combination.

So how do we know which portfolios are attractive to investors? To answer this, we introduce the concept of mean-variance criterion, which states that Portfolio A dominates Portfolio B if E(RA) ≥ E(RB) and σA ≤ σB (i.e. portfolio A offers a higher expected return and lower risk than portfolio B). If such is the case, then investors would prefer A to B.

From the graph, we can infer that portfolios on the downward-sloping portion of the portfolio frontier are dominated by the upward-sloping portion. As such, the points on the upward-sloping portion of the portfolio frontier represent portfolios that investors find attractive, while points on the downward-sloping portion represent portfolios that are inefficient.

According to the mean-variance criterion, any investor would optimally select a portfolio on the upward-sloping portion of the portfolio frontier, which is called the efficient frontier, or minimum variance frontier. The choice of any portfolio on the efficient frontier depends on the investor’s risk preferences.

A portfolio above the efficient frontier is impossible, while a portfolio below the efficient frontier is inefficient.

Complete portfolio and capital allocation line

In constructing portfolios, investors often combine risky assets with risk-free assets (such as government bonds) to reduce risks. A complete portfolio is defined as a combination of a risky asset portfolio, with return Rp, and the risk-free asset, with return Rf.

The expected return of a complete portfolio is given as:

E(Rc) = wpE(Rp) + (1 − wp)Rf

And the variance and standard deviation of the complete portfolio return is given as:

Var(Rc) = w2pVar(Rp), σ(Rc) = wpσ(Rp),

where wp is the fraction invested in the risky asset portfolio.

While the expected excess return of a complete portfolio is calculated as:

E(Rc) – Rf,

if we substitute E(Rc) with the previous formula, we get wp(E(Rp) − Rf).

The standard deviation of the complete portfolio is σ(Rc) = wpσ(Rp), which gives us:

wp = σ(Rc)/σ(Rp)

Therefore, for each complete portfolio:

Or E(Rc) = Rf + Spσ(Rc), where Sp =

The line E(Rc) = Rf + Spσ(Rc) is the capital allocation line (CAL). The slope of the line, Sp, is called the Sharpe ratio, or reward-to-risk ratio. The Sharpe ratio measures the increase in expected return per unit of additional standard deviation.

Optimal portfolio

The optimal portfolio consists of a risk-free asset and an optimal risky asset portfolio. The optimal risky asset portfolio is at the point where the CAL is tangent to the efficient frontier. This portfolio is optimal because the slope of CAL is the highest, which means we achieve the highest returns per additional unit of risk. The graph below illustrates this:

The tangent portfolio weights are calculated as follows:

Summary of capital allocation line

Investors use both the efficient frontier and the CAL to achieve different combinations of risk and return based on what they desire. The optimal risky portfolio is found at the point where the CAL is tangent to the efficient frontier. This asset weight combination gives the best risk-to-reward ratio, as it has the highest slope for CAL.

Efficient Frontier and CAL Template

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## Bandwidth Allocation Control Protocol (Bacp)

Bandwidth Allocation Control Protocol (BACP) is a protocol used in Asynchronous Transfer Mode (ATM) networks to control the allocation of bandwidth among different virtual channels. It is used to ensure that bandwidth is allocated fairly among competing traffic streams, and to prevent any one traffic stream from monopolizing the network.

BACP operates at the edge of the ATM network, in the ATM Adaptation Layer (AAL). When a virtual channel is established between two endpoints, BACP is used to negotiate the amount of bandwidth that will be allocated to that channel. BACP also monitors the usage of the channel, and adjusts the allocated bandwidth as necessary to ensure fair allocation among all channels.

BACP uses a combination of both reservation-based and explicit rate-based methods to allocate bandwidth. In reservation-based allocation, a virtual channel is allocated a fixed amount of bandwidth that it is guaranteed to have access to. In explicit rate-based allocation, a virtual channel is allocated a maximum amount of bandwidth, but it is not guaranteed to have access to that much bandwidth at all times. Instead, it must compete with other channels for the available bandwidth.

BACP also provides mechanisms for handling congestion and ensuring Quality of Service (QoS) for different types of traffic. When network congestion occurs, BACP may reduce the amount of bandwidth allocated to certain virtual channels, or may temporarily block new virtual channel requests, in order to ensure that existing channels continue to receive the guaranteed minimum level of service.

BACP Functions

BACP has several key functions that it performs in order to control the allocation of bandwidth in ATM networks −

Bandwidth negotiation − When a virtual channel is established between two endpoints, BACP is used to negotiate the amount of bandwidth that will be allocated to that channel. This ensures that each channel receives a fair allocation of bandwidth, and prevents any one channel from monopolizing the network.

Monitoring and adjustment − BACP monitors the usage of each virtual channel and adjusts the allocated bandwidth as necessary to ensure fair allocation among all channels. This dynamic adjustment of bandwidth helps to optimize network performance and prevents congestion.

Congestion control − BACP provides mechanisms for handling network congestion by reducing the amount of bandwidth allocated to certain virtual channels or temporarily blocking new virtual channel requests. This ensures that existing channels continue to receive the guaranteed minimum level of service even when the network is congested.

Quality of Service (QoS) support − BACP supports different levels of QoS for different types of traffic. It allows to provide different levels of service for different types of traffic, such as real-time video or audio, and ensures that these types of traffic receive the necessary bandwidth to maintain high-quality service.

Support of different allocation techniques − BACP can use both reservation-based and explicit rate-based methods to allocate bandwidth. Reservation based allocation assign a fixed amount of bandwidth that is guaranteed to the user, while explicit rate-based allocation assigns a maximum amount of bandwidth, but is not guaranteed to have access to that much bandwidth at all times.

In summary, BACP is a protocol that is responsible for allocating bandwidth efficiently and fairly, preventing network congestion and assuring Quality of Service. It utilizes different allocation techniques, monitors the use and adjusts accordingly, as well as controls network congestion in order to ensure optimal network performance.

BACP Commands

BACP commands are used to control and configure the Bandwidth Allocation Control Protocol (BACP) on a device that implements the protocol, such as a router or switch. These commands are used to establish and configure virtual channels, set bandwidth allocation parameters, and monitor and troubleshoot BACP operation.

Here are some examples of common BACP commands −

create vc − This command is used to create a new virtual channel between two endpoints. It is typically used to establish a new connection between two devices.

modify vc − This command is used to modify an existing virtual channel. It can be used to adjust the bandwidth allocation for a channel, or to change other configuration parameters for a channel.

show vc − This command is used to display information about virtual channels. It can be used to view the status and configuration of existing virtual channels, or to troubleshoot problems with virtual channels.

delete vc − This command is used to delete an existing virtual channel. This can be used to terminate a connection between two devices, or to remove a virtual channel that is no longer needed.

show bacp − This command displays information about the current BACP configuration, such as the number of virtual channels that have been established and the amount of bandwidth that is currently allocated to each channel.

debug bacp − This command can be used to enable debugging messages related to BACP operations. It can be useful to troubleshoot issues with BACP.

These are just a few examples of BACP commands that may be available on a device that implements the protocol. The exact commands and command syntax will depend on the specific device and its software version, it’s also important to note that BACP is not widely used and older technology and the commands may be different or not exist in newer equipment.

The BACP header format is used to structure the information that is exchanged between two devices using the Bandwidth Allocation Control Protocol (BACP). The header is typically included in the payload of an ATM cell and contains information that is used by BACP to control the allocation of bandwidth among different virtual channels.

Here is an example of the format of a BACP header −

Field

Size (bits)

Description

Version Number

4

Identifies the version of the BACP protocol that is being used.

Reserved

4

Unused bits that are reserved for future use.

Message Type

8

Indicates the type of BACP message that is being sent. This can include messages such as “bandwidth request,” “bandwidth allocation,” “bandwidth release,” and “bandwidth query.”

Virtual Channel Identifier (VCI)

16

Identifies the virtual channel that the BACP message is related to. Each virtual channel is assigned a unique VCI value.

Virtual Path Identifier (VPI)

8

Identifies the virtual path that the BACP message is related to. A virtual path is a logical grouping of virtual channels that share a common path through the network. The VPI value is used in conjunction with the VCI value to identify a specific virtual channel.

Requested Bandwidth

32

The amount of bandwidth that is being requested or allocated in the BACP message. This field is only present in certain types of BACP messages, such as “bandwidth request” and “bandwidth allocation.”

As you can see the header is composed by fields such as version number, message type, Virtual Channel Identifier, Virtual Path Identifier and Requested bandwidth. Each field contains information that is used by BACP to control the allocation of bandwidth among different virtual channels.

It’s also important to mention that as I mentioned before, BACP is not a widely used protocol today and the header format and structure might not be the same in all devices that implement it, but the general idea of it is similar.

## Area Chart Using Range And Line

Area Chart using Range and Line

Following is an example of a Area Chart using using range and line.

We have already seen the configuration used to draw a chart in Highcharts Configuration Syntax chapter. Now, we will see an example of an Area Chart using using range and line. In addition, we will also see additional configuration. We have changed the type attribute in chart.

series

Configure the chart type to be ‘arearange’ based. chart.type decides the series type for the chart. Here, the default value is “line”.

var series = { type: 'arearange' }; Example

highcharts_area_rangeline.htm

\$(document).ready(function() { var ranges = [ [1246406400000, 14.3, 27.7], [1246492800000, 14.5, 27.8], [1246579200000, 15.5, 29.6], [1246665600000, 16.7, 30.7], [1246752000000, 16.5, 25.0], [1246838400000, 17.8, 25.7], [1246924800000, 13.5, 24.8], [1247011200000, 10.5, 21.4], [1247097600000, 9.2, 23.8], [1247184000000, 11.6, 21.8], [1247270400000, 10.7, 23.7], [1247356800000, 11.0, 23.3], [1247443200000, 11.6, 23.7], [1247529600000, 11.8, 20.7], [1247616000000, 12.6, 22.4], [1247702400000, 13.6, 19.6], [1247788800000, 11.4, 22.6], [1247875200000, 13.2, 25.0], [1247961600000, 14.2, 21.6], [1248048000000, 13.1, 17.1], [1248134400000, 12.2, 15.5], [1248220800000, 12.0, 20.8], [1248307200000, 12.0, 17.1], [1248393600000, 12.7, 18.3], [1248480000000, 12.4, 19.4], [1248566400000, 12.6, 19.9], [1248652800000, 11.9, 20.2], [1248739200000, 11.0, 19.3], [1248825600000, 10.8, 17.8], [1248912000000, 11.8, 18.5], [1248998400000, 10.8, 16.1] ]; var averages = [ [1246406400000, 21.5], [1246492800000, 22.1], [1246579200000, 23], [1246665600000, 23.8], [1246752000000, 21.4], [1246838400000, 21.3], [1246924800000, 18.3], [1247011200000, 15.4], [1247097600000, 16.4], [1247184000000, 17.7], [1247270400000, 17.5], [1247356800000, 17.6], [1247443200000, 17.7], [1247529600000, 16.8], [1247616000000, 17.7], [1247702400000, 16.3], [1247788800000, 17.8], [1247875200000, 18.1], [1247961600000, 17.2], [1248048000000, 14.4], [1248134400000, 13.7], [1248220800000, 15.7], [1248307200000, 14.6], [1248393600000, 15.3], [1248480000000, 15.3], [1248566400000, 15.8], [1248652800000, 15.2], [1248739200000, 14.8], [1248825600000, 14.4], [1248912000000, 15], [1248998400000, 13.6] ]; var title = { text: 'July temperatures' }; var xAxis = { type: 'datetime' }; var yAxis = { title: { text: null } }; var tooltip = { shared: true, crosshairs: true, valueSuffix: 'xB0C' }; var legend = { } var series = [ { name: 'Temperature', data: averages, zIndex: 1, marker: { fillColor: 'white', lineWidth: 2, lineColor: Highcharts.getOptions().colors[0] } }, { name: 'Range', data: ranges, type: 'arearange', lineWidth: 0, linkedTo: ':previous', color: Highcharts.getOptions().colors[0], fillOpacity: 0.3, zIndex: 0 } ]; var json = {}; json.title = title; json.xAxis = xAxis; json.yAxis = yAxis; json.tooltip = tooltip; json.legend = legend; json.series = series; \$('#container').highcharts(json); }); Result

Verify the result.

highcharts_area_charts.htm

## Check Point: Cybersecurity Portfolio Review

Check Point provides a suite of cybersecurity solutions able to protect customers from “5th-generation” cyber attacks.

Check Point Software Technologies provides cybersecurity solutions to enterprises and governments. Since being founded in 1992, Check Point has grown to over 5,400 employees located in 75 offices worldwide, with headquarters in Tel Aviv, Israel and San Carlos, California.

Provides comprehensive and ultra-scalable protection against threats to network security

Choose from a diverse lineup of hardware appliance options

Offer users secure, seamless remote access to corporate networks and resources using multi-factor authentication, endpoint system compliance scanning, and encryption of all transmitted data

Delivers protection to your users, network, data center, endpoints, and IoT

Use the Check Point R81 Cyber Security Platform

Configure and deploy security policies

Inspect network traffic, allocating hardware and core resources accordingly

Respond to threats quickly using event and log management

Support for unified, multi-cloud security

Centralized platform for visualization of all cloud traffic, security alerts, assets, and auto-remediation

Protect and prevent threats across supported third-party platforms, including AWS, Azure, Google, VMware, IBM Cloud, Oracle Cloud, Alibaba Cloud, Kubernetes

Prevent misconfigurations that would threaten compliance with more than 50 frameworks and best practices

Empower DevOps to scale and deploy security solutions with integration tools, like CloudFormation and Terraform

Protect web applications and APIs from threats

Check Point Harmony brings a suite of solutions together to confidently secure your remote workforce.

Email security:

block phishing and malware attacks, protect sensitive business data (data loss prevention (DLP)), and prevent account takeover

Secure access service edge (SASE):

securely connect any remote user or branch office to any network resources, support secure work-from-anywhere (WFA) hybrid environments, deliver remote zero-trust access at any scale to any corporate application

Mobile security:

secure all mobile devices being used by your employees without compromising privacy or negatively impacting usability

Endpoint security:

protect user PCs and laptop from ransomware, phishing, and malware threats

Offers unified security management with 100% breach prevention across your entire security estate

Monitor intelligence through a single access point

Expose, investigate, and mitigate attacks quickly and with 99.9% precision

Joining the Check Point Partner Growth Program delivers sales training and tools, service programs, marketing materials, and provides access to promotions. Check Point is committed to offering partners profitable opportunities through strategic initiatives with the requisite supports to ensure success.

Check Point has assembled the leading technology partners in the security industry to deliver joint solutions designed to “create a cohesive, tightly integrated, secure ecosystem.” Current featured technology partners include AWS, Google Cloud, Microsoft Azure, Servicenow, Splunk, and VMware Velocloud.

By joining Check Point’s MSSP Partner Program, you gain access to customers that are looking to partner with the best security experts to implement, support, and scale Check Point solutions.

Protecting confidential financial data without compromising its availability to customers was the challenge faced by the finance firm SEB Baltics. With thanks to Check Point Infinity Total Protection and Check Point Harmony Endpoint, the bank was able to both manage and protect its assets. Ten years later, Kaur Lillepold, head of network and telephone for SEB Baltics, offered high praise, stating that they “have used Check Point for a very long time, and it is heavily involved in our daily operations.” He goes on to confirm that they, “are very happy with what Check Point provides.”

The service and support provided by Check Point for their security solutions are unparalleled. Consistently applauded for their expertise, Check Point inspires confidence in nearly all customers they assist.

Gartner Peer Insights: 4.5 out of 5

TrustRadius: 7.2 out of 10 for Remote Access VPN, and  8.8 out of 10 for Security Gateway

Gartner Peer Insights: 4.7 out of 5 for Network Security, and 4.5 out of 5 for Posture Management

TrustRadius: 8.0 out of 10 for Network Security, and 8.3 out of 10 for Posture Management

Gartner Peer Insights: 4.5 out of 5 for Endpoint, 4.3 out of 5 for Connect, and 4.6 out of 5 for Mobile

G2: 4.4 out of 5 for Endpoint, 4.7 out of 5 for Connect, 4.5 out of 5 for Email Security, and 4.1 out of 5 for Mobile

TrustRadius: 9 out of 10 for Endpoint, 8.7 out of 10 for Browse, and 8 out of 10 for Mobile

G2: 4.6 out of 5

Not only has Check Point recently been named a Leader for the 22nd time in the 2023 Gartner Magic Quadrant for Network Firewalls Report, 2023 saw Check Point named as a Microsoft Security 20/20 award winner for the Most Transformative Integration Partner.

It would be difficult to accurately measure the market share percentage held by Check Point, given the variety of products and solutions being offered as part of their portfolio. As a provider of security solutions, Check Point has an estimated 0.26% market share, compared to leading competitors,  Symantec with 61.57% and McAfee with 26.70%.

Check Point’s market share improve when you drill down into specific products and solutions, but their competitors also change depending on the category.

Suffice to say, with revenue expected to top \$2.2-\$2.375 billion in 2023, Check Point is fully capable of holding their own playing against the biggest security solution contenders.

## Access Tumblr, Flickr, And Youtube From The Command Line

Tumblr

Although there’s more than one command-line Tumblr client in existence, the one I recommend is a Ruby gem called Tumblr-rb. It’s the only one I know of that supports YAML Ain’t Markup Language (YAML), which is a clean, human-readable way to format documents.

Installation

You must first install Ruby and RubyGems. Once that’s out of the way, you can grab Tumblr-rb with a single command:

gem

install

tumblr-rb

Now symlink the gem so you can use it without having to type out the complete file path every time:

sudo

ln

-s

~

/

.gem

/

ruby

/

1.8

/

bin

/

tumblr

/

usr

/

bin

/

tumblr

Finally, there are a couple of steps required to authorize Tumblr-rb to access your Tumblr account. You need to first register a Tumblr application; you can call it anything you want. The important thing is to get the OAuth consumer key and the secret key. Once you have those, run:

tumblr authorize

You’ll be taken to a page that looks like this:

Enter your credentials and wait for the success message. Now you can use Tumblr-rb.

Usage

Tumblr-rb has an online manual as well as some more developer-oriented documentation. Here is a quick reference for some of the commands you can run:

Make a text post: tumblr post my-formatted-post.txt

Post a URL and put it in your queue:

Post a multimedia (image, audio, or video) file and save it as a draft: tumblr post

-d

my-new-song.wav

Post text from STDIN: tumblr post

"I'm posting to Tumblr from my Raspberry Pi!"

Post from STDIN using a YAML file:

Installation

First of all, you need Python 2.*. Now download the latest chúng tôi sources from GitHub:

Fill out the application with any name and description you want and agree to the terms at the bottom. Once you submit your application, you’ll get a key and a secret. Add these lines to your “~/.bashrc”, replacing “[key]” and “[secret]” appropriately, so that your system will remember them from one session to the next:

export

=

'[key]'

export

=

'[secret]'

Start a new shell session to make the changes take effect. Enter the chúng tôi directory you downloaded from GitHub and the subdirectory “uploadr.” Run:

Usage

Well, almost ready to roll. We need to edit a few lines in chúng tôi to give the program some instructions. On line 56, specify the directory your images are stored in:

IMG_DIR =

"~/Pictures/PhotosForFLickr/"

You can also set it up to receive command-line arguments for the title, description, and tags:

FLICKR =

{

"title"

: sys.argv

[

1

]

,

"description"

: sys.argv

[

2

]

,

"tags"

: sys.argv

[

3

]

,

"is_public"

:

"1"

,

"is_friend"

:

"0"

,

Now you can upload the images from your chosen directory with a title, description, and tags:

python chúng tôi

"Screenshot"

"This is a screenshot."

"screenshots, Linux"

Previously, we covered how to manage your YouTube account using GoogleCL. But what if you just want to be a consumer, not a producer? For simply watching YouTube videos from the command line, there are two notable tools: youtube-dl and youtube-viewer.

If you’re using Linux, you can probably install both of these tools with your package manager. Alternatively, you can grab the sources from GitHub and install them yourself:

Download a video in MP4 format and use the title for the file name:

View all available formats and their codes for a video:

--extract-audio

--audio-format

"vorbis"

Once you’ve downloaded a video, you can watch it in a terminal using MPlayer with an ASCII art library such as AAlib (for monochrome playback) or libcaca (for viewing in color). For example:

Unlike youtube-dl, youtube-viewer is interactive. When you enter the command youtube-viewer, you’ll be taken to an interactive prompt where you can search for videos or enter :h for help. Searching will return the top twenty results.

To watch a video, enter its number into the prompt. You may initially get the mplayer: could not connect to socket error; just give it a moment, and the video will start playing.

If you are using youtube-viewer from a text-only console, as opposed to a terminal emulator (any “terminal” run in an X session is actually a terminal emulator), youtube-viewer will automatically play videos with aalib. Depending on the size of your console, the picture may get distorted. For example, here I split the screen using Tmux for the purpose of grabbing a screenshot, and the video appeared elongated:

These are some other commands you can run inside youtube-viewer:

:a

(

uthor

)

=i,i

Like or dislike a video: :

(

dis

)

like

=i

Subscribe to an author’s channel: :

subscribe

=i

Show related videos: :r

(

related

)

=i

Play videos from your search results in a specific order:

3

-

5

,

8

10

7

1

Conclusion

Rebecca "Ruji" Chapnik

Ruji Chapnik is a freelance creator of miscellanea, including but not limited to text and images. She studied art at the University of California, Santa Cruz and writing at Portland State University. She went on to study Linux in her bedroom and also in various other people's bedrooms, crouched anti-ergonomically before abandoned Windows computers. Ruji currently lives in Portland, Oregon. You can find her experiments at chúng tôi and her comics at dondepresso.rujic.net.

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## What Is Capital Structure? Most Important Points

In this article, we will discuss the gist of the firm’s capital structure.

Start Your Free Investment Banking Course

The discount rate is a function of the risk inherent in any business and industry, the uncertainty regarding the projected cash flows, and the assumed capital structure. In general, discount rates vary across different businesses and industries. The greater the uncertainty about the projected cash stream, the higher the appropriate discount rate and the lower the current value of the cash stream.

Extract the Capital Structure from Annual Report

We require the proportion of Equity and Debt in the capital structure to calculate the discount rate using our ABC example. For the capital structure calculations, the annual reports of ABC have provided us with the following information on Debt and Equity related items from the footnotes.

The capitalization table of ABC company is as per below.

Understanding the Capital Structure of the Firm Short-Term Borrowings

Short-term borrowings are an account shown in the current liabilities portion of a company’s balance sheet. This account comprises any debt incurred by a company due within one year. A company typically takes out short-term bank loans to make up the debt in this account. ABC needs to pay \$5.2 million within one year and the interest (coupon) of 3.2%.

Revolver

Revolving credit is a type of credit that does not have a fixed number of payments, in contrast to installment credit. Examples of revolving credits used by consumers include credit cards or overdraft facilities. Corporate revolving credit facilities are typically useful to provide liquidity for a company’s day-to-day operations. In the context of company ABC, they have a pre-approved loan facility of up to \$30 million. However, ABC has drawn only \$14.2 from the bank.

Typical Characteristics of Revolver Loan

The borrower may use or withdraw funds up to a pre-approved credit limit.

The available credit decreases and increases as funds are borrowed and repaid.

The credit may be used repeatedly.

The borrower makes payments based only on the amount they’ve actually used or withdrawn, plus interest.

The borrower may repay over time (subject to any minimum payment requirement) or in full at any time.

In some cases, the borrower needs to pay a fee to the lender for any money that is undrawn on the revolver; this is especially true of corporate bank loan revolving credit facilities.

Bonds

The authorized issuer is obligated to pay the holders a debt in a bond and, depending on the bond terms, must pay interest (the coupon) and/or repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals. Company ABC has taken a loan of \$80 million, out of which ABC needs to repay the amortizing portion of the bond i.e. principal repayment of \$12 million within a year.

Long-term = \$80 – \$12 = \$68 (maturity of more than one year)

Short Term = \$ 12 million (amortizing portion, principal repayment)

Convertible Bonds

A convertible bond is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value at an agreed-upon price. It is a hybrid security with debt- and equity-like features. Although it typically has a low coupon rate, the instrument carries additional value through the option to convert the bond to stock, thereby participating in further growth in the company’s equity value. The investor receives the potential upside of conversion into equity while protecting the downside with cash flow from the coupon payments. In ABC, convertible bonds have a face value of \$100 and a coupon rate of 4.5% (interest expense). The conversion price is \$25, which implies each bond converts into 4 shares.

Straight Preferred Stocks

Preferred stock, also called preferred shares, is a special equity security that resembles properties of an equity and a debt instrument and is generally a hybrid instrument. Preferred Stocks are senior (i.e. higher ranking) to common stock but are subordinate to bonds.

This stock usually carries no voting rights but may carry priority over common stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend before any dividends are paid to common stockholders.

Cumulative versus Non-cumulative Preferred Stocks

Preferred stock can either be cumulative or noncumulative. A cumulative preferred stock requires that if a company fails to pay any dividend or amount below the stated rate, it must make up for it later. Dividends accumulate with each passed dividend period, which can be quarterly, semi-annually, or annually. When a company fails to declare a dividend in time, it is said to have “passed” the dividend, and all passed dividends on a cumulative stock become dividends in arrears. Investors refer to a stock that lacks this feature as a noncumulative or straight preferred stock, where any passed dividends are permanently lost if not declared.

Convertible Preferred Stocks

In ABC, the preferred stock’s face value (FV) is \$18. Each preferred stock converts to one ordinary share at a conversion price of \$20.

The key to getting WACC correct is to get the capital structure right. Hence, we need to classify our capitalization table from the perspective of Debt and Equity.

Summary of Classification as Debt and Equity

What Next?

In this article, we have understood the capital structure of the firm. In our next article, we will understand convertible features. Till then, Happy Learning!

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