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PART VII: CAPITAL STRUCTURE DECISIONS IN IMPERFECT CAPITAL MARKETS
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PART VII: CAPITAL STRUCTURE DECISIONS IN IMPERFECT CAPITAL MARKETS
by Guofu Zhou, Edwin H. Neave, Frank J. Fabozzi
Financial Economics
Cover Page
Title Page
Copyright
Contents
PREFACE
Acknowledgments
ABOUT THE AUTHORS
1: INTRODUCTION
1.1 MICROECONOMIC THEORY: INDIVIDUALS, MANAGERS, AND MARKETS
1.2 FINANCIAL ECONOMIC THEORY: INDIVIDUALS, MANAGERS, AND MARKETS
1.3 ROAD MAP FOR THE BOOK
QUESTIONS
REFERENCES
PART I: FINANCE IN A CERTAINTY WORLD WITH A PERFECT CAPITAL MARKET
2: CONSUMER FINANCIAL DECISIONS
2.1 THE CONSUMPTION-INVESTMENT PROBLEM
2.2 INITIAL WEALTH IS THE ONLY CONSTRAINT ON CONSUMER DECISIONS
2.3 THE MEANING OF THE MARKET RATE OF INTEREST
2.4 PRACTICAL IMPORTANCE OF CONSUMPTION-INVESTMENT THEORY
KEY POINTS
QUESTIONS
3: CREATING WEALTH BY INVESTING IN PRODUCTIVE OPPORTUNITIES
3.1 THE ENTREPRENEURIAL FIRM—PRODUCTION AND INVESTMENT DECISIONS
3.2 INVESTMENT DECISIONS MADE BY MANAGERS ON BEHALF OF OWNERS
3.3 EXAMPLE: AGING WINE
3.4 CONSEQUENCES FOR INVESTMENT AND FINANCING DECISIONS
KEY POINTS
QUESTIONS
REFERENCES
4: HOW INVESTORS VALUE FIRMS
4.1 VALUE BASED IN A FIRM'S CAPACITY TO GENERATE INVESTOR RETURNS
4.2 WHAT GROWTH STOCKS ARE AND WHAT RETURNS THEY YIELD
4.3 MARKET VALUES AND DIFFERENT PLANNING HORIZONS
QUESTIONS
REFERENCES
5: FIRM FINANCING DECISIONS IN A PERFECT CAPITAL MARKET
5.1 DEBT VS. EQUITY
5.2 CAPITAL STRUCTURE AND FINANCIAL LEVERAGE
5.3 CAPITAL STRUCTURE AND TAXES
5.4 THE COST OF CAPITAL
5.5 CAPITAL STRUCTURE IN A PERFECT CAPITAL MARKET: THE IRRELEVANCE THEORY
KEY POINTS
QUESTIONS
REFERENCES
6: FIRM INVESTMENT DECISIONS
6.1 INVESTMENT DECISIONS AND OWNERS’ WEALTH MAXIMIZATION
6.2 CLASSIFICATION OF INVESTMENT PROJECTS
6.3 A PROJECT'S INCREMENTAL CASH FLOWS
6.4 APPLYING THE MARKET VALUE RULE TO INDEPENDENT PROJECTS
6.5 COMMONLY USED ASSESSMENT CRITERIA IN A CERTAIN WORLD WITH A PERFECT CAPITAL MARKET
6.6 INVESTMENT CRITERIA IN PRACTICE
KEY POINTS
QUESTIONS
REFERENCES
PART II: FINANCIAL SYSTEM
7: FINANCIAL SYSTEMS, GOVERNANCE, AND ORGANIZATION
7.1 FINANCIAL SYSTEM FUNCTIONS
7.2 FINANCIAL SYSTEM GOVERNANCE
7.3 FINANCIAL SYSTEM ORGANIZATION
KEY POINTS
QUESTIONS
REFERENCES
8: MARKET, INTERMEDIARY, AND INTERNAL GOVERNANCE
8.1 FINANCIAL MARKET GOVERNANCE
8.2 NON-MARKET GOVERNANCE: FINANCIAL INTERMEDIARIES
8.3 INTERNAL GOVERNANCE
KEY POINTS
QUESTIONS
REFERENCES
PART III: TOOLS FOR COPING WITH RISK
9: THE MICROECONOMIC FOUNDATION OF FINANCIAL ECONOMICS
9.1 PRESCRIPTIVE AND DESCRIPTIVE APPROACHES
9.2 ASSUMPTIONS UNDERLYING FINANCIAL ECONOMICS
KEY POINTS
QUESTIONS
REFERENCES
10: CONTINGENT CLAIMS AND CONTINGENT STRATEGIES
10.1 STATES OF THE WORLD
10.2 CONTINGENT CLAIMS AND THEIR VALUE
10.3 INVESTOR'S UTILITY MAXIMIZATION IN CONTINGENT CLAIMS MARKETS
10.4 INCOMPLETE MARKETS FOR CONTINGENT CLAIMS
10.5 MODIGLIANI-MILLER REVISITED
10.6 FINANCIAL INSTRUMENTS AS CONTINGENT CLAIMS
10.7 CONTINGENT STRATEGIES
KEY POINTS
QUESTIONS
REFERENCES
11: RISK AND RISK MANAGEMENT
11.1 RISK AND UNCERTAINTIES
11.2 DECISION CRITERIA
11.3 METHODS OF RISK TRANSFER
11.4 CHARACTERISTICS OF PROBABILITY DISTRIBUTIONS
11.5 EXPECTED UTILITY THEORY AND ARROW-PRATT RISK AVERSION
KEY POINTS
QUESTIONS
REFERENCES
12: ON CHOOSING RISK MEASURES
12.1 USING RISK MEASURES
12.2 MEASURES OF RISKINESS
12.3 CONSISTENT RISK MEASURES AND STOCHASTIC ORDERINGS
12.4 VALUE AT RISK AND COHERENT RISK MEASURES
KEY POINTS
QUESTIONS
REFERENCES
PART IV: SELECTION AND PRICING OF RISKY ASSETS
13: MEAN-VARIANCE PORTFOLIO CHOICE
13.1 TWO RISKY ASSETS
13.2 MANY RISKY ASSETS
13.3 ADDING A RISK-FREE ASSET
13.4 MARKOWITZ PORTFOLIOS
13.5 PRACTICAL ISSUES
13.6 ADVANCED TOPICS
KEY POINTS
QUESTIONS
REFERENCES
14: CAPITAL ASSET PRICING MODEL
14.1 CAPM ASSUMPTIONS
14.2 DERIVING THE CAPITAL MARKET
14.3 DERIVING THE CAPM
14.4 CAPM IN THE ABSENCE OF A RISK-FREE ASSET
14.5 IMPLICATIONS OF THE CAPM
14.6 AN ALTERNATIVE DERIVATION
14.7 ESTIMATING BETA RISK
14.8 APPLICATION OF CAPM IN INVESTMENT MANAGEMENT
14.9 TESTS OF THE CAPM
KEY POINTS
QUESTIONS
APPENDIX 14.1: RUBINSTEIN'S PROOF OF THE CAPM
REFERENCES
15: ARBITRAGE PRICING THEORY AND FACTOR MODELS
15.1 APT AND CAPM
15.2 APT IN A SPECIAL ONE-FACTOR MODEL
15.3 APT IN THE MULTIFACTOR MODEL
15.4 FACTOR MODELS
15.5 FACTOR MODEL ESTIMATION
KEY POINTS
QUESTIONS
REFERENCES
16: GENERAL PRINCIPLES OF ASSET PRICING
16.1 ONE-PERIOD FINITE STATE ECONOMY
16.2 PORTFOLIOS AND MARKET COMPLETENESS
16.3 THE LAW OF ONE PRICE AND LINEAR PRICING
16.4 ARBITRAGE AND POSITIVE STATE PRICING
16.5 THE FUNDAMENTAL THEOREM OF ASSET PRICING
16.6 DISCOUNT FACTOR MODELS
16.7 EQUITY RISK PREMIUM PUZZLE
KEY POINTS
QUESTIONS
REFERENCES
17: PRICING CORPORATE SECURITIES
17.1 PROFIT-SEEKING ELIMINATES ARBITRAGE OPPORTUNITIES
17.2 PRICING SECURITIES RELATIVE TO EACH OTHER
17.3 CALCULATING RISK-NEUTRAL PROBABILITY MEASURES
17.4 USING RISK-NEUTRAL PROBABILITIES FOR SECURITIES VALUATION
17.5 DEBT VERSUS EQUITY
17.6 APPLICATION: BOND VALUATION AND MARKET RISK
KEY POINTS
QUESTIONS
REFERENCES
PART V: DERIVATIVE INSTRUMENTS
18: PRICING DERIVATIVES BY ARBITRAGE: LINEAR PAYOFF DERIVATIVES
18.1 LINEAR VERSUS NONLINEAR PAYOFF DERIVATIVE INSTRUMENTS
18.2 FORWARD CONTRACTS
18.3 FUTURES PRICING
18.4 SWAPS
KEY POINTS
QUESTIONS
REFERENCES
19: PRICING DERIVATIVES BY ARBITRAGE: NONLINEAR PAYOFF DERIVATIVES
19.1 BASIC CONCEPTS
19.2 SIMPLE USES OF OPTIONS
19.3 PUT-CALL PARITY
19.4 KEY IDEA FOR VALUATION
19.5 SINGLE-PERIODB IN OMIAL MODEL
19.6 BLACK-SCHOLES FORMULA
19.7 BINOMIAL MODEL
19.8 AMERICAN OPTIONS
19.9 ARBITRARY PAYOFFS AND GENERAL MODELS
Appendix 19.1 Derivation of the Black-Scholes Formula
KEYPOINTS
QUESTIONS
REFERENCES
PART VI: CAPITAL MARKET IMPERFECTIONS AND THE LIMITS TO ARBITRAGE
20: CAPITAL MARKET IMPERFECTIONS AND FINANCIAL DECISION CRITERIA
20.1 TYPES OF CAPITAL MARKET IMPERFECTIONS
20.2 SOME EFFECTS OF CAPITAL MARKET IMPERFECTIONS
20.3 NEED FOR AN INTEGRATED APPROACH TO FINANCIAL DECISION MAKING
20.4 CHOOSING CRITERIA FOR FINANCIAL DECISIONS
20.5 MOTIVATING MANAGERS TO MEET OWNERS’ OBJECTIVES: AGENCY THEORY
KEY POINTS
QUESTIONS
REFERENCES
21: IMPEDIMENTS TO ARBITRAGE
21.1 SECURITIES MARKETS AND LIQUIDITY
21.2 LIMITS TO ARBITRAGE
21.3 MARKET SEGMENTATION
21.4 INFORMATIONAL ASYMMETRIES AND CREDIT MARKET EQUILIBRIA
21.5 MARKET FAILURE
21.6 FINANCIAL SYSTEM EXTERNALITIES
KEY POINTS
QUESTIONS
REFERENCES
PART VII: CAPITAL STRUCTURE DECISIONS IN IMPERFECT CAPITAL MARKETS
22: WHEN CAPITAL STRUCTURE MATTERS
22.1 EFFECT OF CORPORATE TAXATION ON LEVERAGE
22.2 CAPITAL STRUCTURE AND FINANCIAL DISTRESS
22.3 FINANCIAL DISTRESS AND CAPITAL STRUCTURE
22.4 HETEROGENEOUS EXPECTATIONS
22.5 AGENCY EFFECTS
22.6 THEORY OF DIVIDEND PAYMENTS
22.7 IS THERE AN OPTIMAL CAPITAL STRUCTURE?
22.8 DYNAMIC MODELS
KEY POINTS
QUESTIONS
REFERENCES
23: FINANCING DECISIONS IN PRACTICE
23.1 ESTIMATING THE COSTS OF DIFFERENT FUNDING SOURCES
23.2 TIMING THE ISSUANCE OF DEBT
23.3 CREDITORS, INVESTORS, AND CAPITAL STRUCTURE CHOICES
23.4 SIGNIFICANCE OF TECHNICAL INSOLVENCY
23.5 RESTRICTIVE COVENANTS AND AGENCY COSTS
23.6 DIVIDEND POLICY
23.7 REPURCHASING THE FIRM'S COMMON STOCK
23.8 PREEMPTIVE RIGHTS OFFERING
23.9 CONTINGENCY PLANNING AND CAPITAL STRUCTURE CHOICES
KEY POINTS
QUESTIONS
REFERENCES
24: FINANCIAL CONTRACTING AND DEAL TERMS
24.1 COSTS OF DEALS
24.2 INFORMATIONAL CONDITIONS
24.3 MORAL HAZARD 9
24.4 COMPLETE CONTRACTS
24.5 INCOMPLETE CONTRACTS: INTRODUCTION
24.6 INCOMPLETE CONTRACTS: FURTHER COMMENTS
24.7 ISSUANCE OF MULTIPLE DEBT CLAIMS
24.8 SECURITIZATION
KEY POINTS
QUESTIONS
REFERENCES
PART VIII: INCORPORATING RISK IN CAPITAL BUDGETING DECISIONS
25: CAPITAL EXPENDITURE PLANS IN A RISKY WORLD
25.1 A MARKET VALUE CRITERION
25.2 COMPARING NEW AND EXISTING EARNINGS RISKS TO OBTAIN OPTIMAL CAPITAL EXPENDITURE PLANS
25.3 REQUIRED RATES OF RETURN: FIRM, DIVISION, AND PROJECT
25.4 DEPRECIATION TAX SHIELD IN A RISKY WORLD
25.5 SINGLE-PERIOD VERSUS MULTI-PERIOD INVESTMENT MODELS
KEY POINTS
QUESTIONS
REFERENCES
26: EVALUATING PROJECT RISK IN CAPITAL BUDGETING
26.1 RISK-ADJUSTED DISCOUNT RATE
26.2 CERTAINTY-EQUIVALENT APPROACH AND ITS APPLICATION IN PRACTICE
26.3 MEASURING A PROJECT'S STAND-ALONE RISK
26.4 MEASURING A PROJECT'S MARKET RISK
26.5 CONTINGENCY PLANNING OF CAPITAL EXPENDITURES
26.6 REAL OPTIONS VALUATION
KEY POINTS
QUESTIONS
REFERENCES
SUBJECT INDEX
AUTHOR INDEX
WEB–APPENDIX A: DEAL TERMS
A.1 COSTS OF DEALS
A.2 INFORMATIONAL CONDITIONS
REFERENCES
WEB–APPENDIX B: CORPORATE DEBT FUNDING INSTRUMENTS
B.1 CORPORATE BONDS
B.2 MEDIUM-TERM NOTES
B.3 COMMERCIAL PAPER
B.4 BANK LOANS
WEB–APPENDIX C: INVESTMENT BANKERS AND THE ISSUANCE OF SECURITIES
C.1 PUBLIC ISSUANCE OF SECURITIES
C.2 PRIVATE PLACEMENT OF SECURITIES
WEB-APPENDIX D: CREDIT RISK
D.1 DEFAULT RISK
D.2 DOWNGRADE RISK
D.3 CREDIT RISK TRANSFER MECHANISMS
REFERENCES
WEB-APPENDIX E *: FINANCIAL STATEMENTS
E.1 ACCOUNTING PRINCIPLES
E.2 THE BALANCE SHEET
E.3 INCOME STATEMENT
E.4 STATEMENT OF CASH FLOWS
E.5 STATEMENT OF STOCKHOLDERS’ EQUITY
E.6 FOOTNOTES TO FINANCIAL STATEMENTS
REFERENCES
WEB-APPENDIX F *: FINANCIAL RATIO ANALYSIS
F.1 RETURN-ON-INVESTMENT RATIOS
F.2 LIQUIDITY
F.3 PROFITABILITY RATIOS
F.4 ACTIVITY RATIOS
F.5 FINANCIAL LEVERAGE RATIOS
F.6 COMMON-SIZE ANALYSIS
REFERENCES
WEB-APPENDIX G *: ESTIMATING CASH FLOWS OF CAPITAL BUDGETING PROJECTS
G.1 OPERATING CASH FLOWS
G.2 INVESTMENT CASH FLOWS
G.3 NET CASH FLOWS
WEB–APPENDIX H: MERGER AND ACQUISITION STRATEGIES
H.1 MERGERS AND ACQUISITIONS IN A PERFECT CAPITAL MARKET
H.2 MERGERS AND ACQUISITIONS IN AN IMPERFECT CAPITAL MARKET
REFERENCES
WEB–APPENDIX I: CONGLOMERATES AS A MEANS OF OVERCOMING CAPITAL MARKET IMPERFECTIONS
REFERENCE
WEB–APPENDIX J: LEASE FINANCING
J.1 LEASING FUNDAMENTALS
J.2 COST OF LEASING
J.3 RISK OF OBSOLESCENCE AND DISPOSAL OF EQUIPMENT
J.4 VALUING A LEASE: THE LEASE OR BORROW-TO-BUY DECISION
REFERENCES
WEB–APPENDIX K: TAYLOR SERIES APPROXIMATION
WEB-APPENDIX L: SOME ELEMENTARY CONCEPTS INVOLVING PROBABILITY
L.1 PROPERTIES OF THE EXPECTED VALUE OF A RANDOM VARIABLE
L.2 MEASURES OF DISPERSION FOR RANDOM VARIABLES
L.3 CORRELATION AND COVARIANCE
WEB–APPENDIX M: CONTINUOUS PROBABILITY DISTRIBUTIONS
M.1 CONTINUOUS RANDOM VARIABLE
M.2 PROBABILITY DISTRIBUTION FUNCTION, PROBABILITY DENSITY FUNCTION, AND CUMULATIVE DISTRIBUTION FUNCTION
M.3 THE NORMAL DISTRIBUTION
M.4 STUDENT'S t -DISTRIBUTION
M.5 LOGNORMAL DISTRIBUTION
M.6 STABLE DISTRIBUTIONS
REFERENCES
WEB–APPENDIX N: CONTINUOUS INTEREST RATES
WEB-APPENDIX O *: FUNDAMENTALS OF MATRIX ALGEBRA
O.1 VECTORS AND MATRICES DEFINED
O.2 SQUARE MATRICES
O.3 DETERMINANTS
O.4 SYSTEMS OF LINEAR EQUATIONS
O.5 LINEAR INDEPENDENCE AND RANK
O.6 VECTOR AND MATRIX OPERATIONS
O.7 EIGENVALUES AND EIGENVECTORS
WEB–APPENDIX P: PRINCIPAL COMPONENT ANALYSIS IN FINANCE
SUBJECT INDEX (WEB-APPENDIX A TO P)
AUTHOR INDEX (WEB-APPENDIX A TO P)
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22: WHEN CAPITAL STRUCTURE MATTERS
PART VII
C
APITAL
S
TRUCTURE
D
ECISIONS IN
I
MPERFECT
C
APITAL
M
ARKETS
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