Finance Leasing Manual - FLM6.44

Finance lessors: residual value risk

More recently, a greater element of uncertainty has been created for finance lessors because competition has forced them in some cases to take part of their return in the form of a share of the sale proceeds of the asset at the end of the lease. This 'residual value' is often uncertain; so the risks are greater and more judgment is needed. Sometimes lessors try to reduce the uncertainty by insuring the residual value. In some markets - such as car leasing - second hand values are generally reasonably predictable and finance lessors have increasingly offered terms which assume part of the lessor's turn will come from the sale price of the car.

The sensible trader in search of finance to acquire an asset will get quotes from various finance lessors and banks. Then the trader will look at the question the other way round. Which of the possible sources of finance will offer the best net present value from its point of view?