D/E ratio being high is considered bad for companies floating FI bonds, not investors who have taken

leverage or debt to invest in FI bonds. This is because a company having too much debt means it has
that many obligations to fulfill, and the risk of company going bankrupt and unable to pay creditors
rises. In the current case, this statement is in appropriate because we are not the company, we are
investors, we cannot consider FI instruments we have purchased as debt.

The 2nd statement only talks about the risk in investors choice. Investor can risk his money in the
equity markets and nothing about future cf’s , or put it in the fixed income market and have clear
idea about cf’s. therefore, it is not risky in that you know the cf’s. However, certain base risks
definitely exist. Such as default risk, etc.

Problem1

you Z

price of house 100 100

Downpayment 25 0
Amount owed at t0 75 0
Value of house at t1 200 200
Amount left after loan repayment 125 -
ROI 400% 100%

Your Return on investment is 400%. Z’s return on investment is 100%

Problem 2

X Y
price of house 200 200
Downpayment 50 0
Loan taken 150 0
New price 100 100
Amount owed after selling house 50 -
ROI -200% -50%

Return on investment of X is -200%, Return on Investment of Y is -50%

Problem 3 and 4.

Leverage amplifies returns or losses. So, a risk can be taken that you will only make gains, and
amplify them. But in case there are losses, those are also amplified and you will owe much more
than in a situation without leverage. It is possible even to lose more than what you borrowed,
depending on the leverage taken, and the loss in value of asset bought.