Efficient Capital Markets: price reflects available Info, Investors receive fair price when Interact, firms get fair price for securities It sells Apt= Apt-l + Expected $ return given risk Random price error E(Art) + Error t (abnormal return, efficient make makes unpredictable) Raft + B(Arm – Raft) Weak: past market info, weak form efficiency, tech analysis will fail Semi-strong: all public info, repurchase info, semi strong form efficiency, fundamental analysis will fail
Strong: all information, inside info, strong form efficiency Examine make Info: can It be used to generate higher return than Justified given risk? (abnormal return) Abnormal Return; Art ; (RPR * B(Arm-Raft)) If +1- make Is Inefficient Capital Structure: mix of securities (D&E), assume shareholders interests are served by maxing value of firm Interest = Debt*r Levered Firm: PEPS= Earnings After Interest/#shares bought Buy unleavened equity and borrow on own account: With shares of unwell equity, calculate payoff for all outcomes (erect, mod, expo) Borrow $ at calculate Interest ($*r)
Find net payoff (payoff-Into) CLC Homemade leverage, if net cost is $20, levered equity SIS,’share With perfect competitive market and no taxes, value doesn’t change with capital structure (FL=Vi) FL= Vi + Etc – IV of expected costs of financial debt Costs of financial distress: Direct Costs – Legal and administrative – Empirically costs on aver are about 3% of value of firm when In bankruptcy >Prop of bankruptcy 5%, expected costs- . 5% Indirect Costs ; Impaired ability to do business >Estimate of costs 8-20% – Agency costs >Stockholders control firm and are “agents” for bondholders When firm is in distress, stockholders may make decisions that do not maximize value of firm 0 cost When firm is in financial distress, equity holders want risky projects -May reject positive NAP (if safe) and accept Eng NAP (if risky) Equity holders milk firm of its value- pay divas and extract perks bondholders need protection bond covenants Tradeoff Theory of Capital Structure: managers choose level of debt to Max value of firm tradeoff benefits (Debt tax shield) vs…. Cost (IV expo cost of distress) -observed debt levels too low for tradeoff theory to be complete explanation
