Unit 1 Flashcards
1
Q
Arbitrage opportunity
A
Set of non-positive trades that yield a risk-free profit
2
Q
M-M theorem assumptions
A
Assumptions
- Total cash flows availabe for distribution among security holders don’t depend on the firm’s financial structure
- PCM, perfect information, there is another firm of the same risk class
- Absence of arbitrage opportunities
3
Q
M-M propositions
A
- Total market value of the firm is independent of its capital structure
- Cost of capital: insofar as debt is riskless, the expected ROE is an increasing function of the debt-equity ratio
- Dividend invariance: TMV is independent of the dividend policy
- Shareholders indifference: when starting-up or if existing security holders are inmune to dilution, shareholders are indifferent to the firms’ financial policy
4
Q
Arrow security
A
Security that pays one unit of consumption when one particular state of the world is realized and nothing otherwise
5
Q
Complete markets definition
A
There exists a complete set of arrow securities
- As long as number of states of the world=number of linearly independent return profiles we have complete markets
6
Q
Prices of state contingent assets in absence of arbitrage
A
7
Q
ROA, ROD and ROE definitions
A
8
Q
Detail proposition 2
A
If debt is riskless, R_D is constant and, then, R_E increases linearly with D/E
9
Q
Call
A
Buyer of the option has the right to buy and asset at the strike price
10
Q
Put option
A
Buyer of the option has the right to sell an option at the strike price
11
Q
Relationship put-call-equity-debt
A
