Question

Assuming a project’s investment performance (ex post) is perfectly consistent with prior expectations at the time it investment was initiated, which member of the capital stack in a fair deal should achieve the highest return, unadjusted for risk?

The mezzanine lender.

None, all should achieve identical returns.

The preferred equity position.

The subordinated equity position.

Answer 1

The correct option is : The subordinate equity position.

A mezzanin lender is debt lender. However, lender has right to convert to equity in case of default. There is no default and hence, the interest paid to debt is limited.

A preferred equity position is paid fixed rate of dividend, which is decided at time of issue of preferred stock. Therefore, payment to preferred equity is limited.

Subordinated equity position are those people who are subordinate owner. They take huge risk and therefore they are entitled for huge returns. Hence, they should get highest return.

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