Comps

Question 1

Central limit theorem- when does it apply?

Answer 1

When sample size is large enough, generally n > 30

Question 2

The cost of capital, corporation finance, and the theory of investment,

Modigliani and Miller, 1958

Answer 2

• Perfect Capital Market
  
  • Frictionless: all securities are infinitely divisible, info is costless and available, no transaction costs or taxes.
  • All financial assets arrangement available to firms are available to individuals: individual investors can issue claims against a given distribution with his liability limited to the period 2 market value from this distribution.
  • Investors are indifferent whether a claim against a given distribution is issued by a firm or individual.
  • There are always perfect substitutes for any securities in the market, and individual and firms are “atomistic competitors” in that their activities have no effect on the prices of other securities.
  • Investors are assumed to maximize their own benefits, and protect themselves against any expropriating activities.
  • Bondholders: “Me First” rule.

Question 3

Modigliani and Miller, 1958

The cost of capital, corporation finance, and theory of investment.

Answer 3

• The market value of a firm in the two-period risk class model
• The market prices of a firm’s securities are derived by comparing them with prices of identical positions in other firms from the same risk class
• First, they show that given its production decision at period 1 or the probability distribution of its total earnings at period 2, the total market value of a firm is independent of its financing decisions
• Second, they show that a firm’s financing decisions are a matter of indifference for any of its security holders.

Question 4

Modigliani and Miller, 1958

Answer 4

Total market value of a firm is independent of its financing decisions.

Definition of same risk class:

X_i(t) = å X_j(t)

Question 5

The Capital Structure Puzzle

Myers, 1984

Answer 5

• Static tradeoff theory
• Pecking order hypothesis
• Corporate financing behavior

Myers, 1984

The Capital Structure Puzzle

Question 6

Static tradeoff

Answer 6