Financial Markets and Investment Analysis
13 Pages Posted: 23 Jul 2013
Date Written: December 12, 2012
The firms can increase their capital by 2 ways: issuing bonds or issuing shares. The relation between them determines the leverage of the firm. Till recent years, firms were considering the leverage balance while they planned to increase the capital. But in recent years, asset financing with debt has exceeded the equity one. The reasons of this, can be pointed as new innovations in the financial markets and new understanding of the capital structure theory. The main understanding was high geared companies have high risk of capital structure, so that shareholders will require risk premium for the extra risks. But the modern understanding of the capital structure by Modigliani and Miller which makes the leverage risk irrelevant was the first challenge against the distinctions between debt and equity. The theory says that financing with debt or equity won't affect the cost of capital.
Keywords: debt, equity, hedging, business valuation
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