Capital Structure, Interest Rates and Credit Ratings
Capital Structure
Capital Structure, Interest Rates and Credit Ratings
Prepared by Ece SARAÇOĞLU BILGI, MSc in International Finance INF 503 - Financial Economics and Interest Rates
December 2012
TABLE OF CONTENTS I. II. III. a) b) c) d) e) f) g) h) i) j) k) l) m) n) o) p) q) IV. V. Why Capital Structure Matters To Investments How Debt and Equity Financing Differ Choosing Between Debt and Equity Financing Process Ownership rights Rights over profit Ease of doing business Repayment Cost to company Future funding Choice of capital Obtained from Debt-to-equity ratio Requirements Advantages Disadvantages Application process Credit check Term Options Other The Debt-to-Equity Ratio
The Optimal Capital Structure a) Firm Value and Stock Value b) Capital Structure and the Cost of Capital How Financial Leverage Affects the EPS and ROE of a Firm How Interest Rates Affect the Demand for Debt and Equity Capital
VI. VII. VIII.
The Significance of Credit Ratings for Capital Structure a) Regulations on Bond Investment b) Information Content of Ratings c) Costs Directly Imposed on the Firm
IX. Credit Ratings in the Context of Existing Capital Structure Theories a) Tradeoff Theory b) Pecking Order Theory X. REFERENCES
2
Why Capital Structure Matters To Investments A firm’s capital structure is the relative proportions of debt, equity, and other securities that it has outstanding or how a firm pays for its assets. The term capital structure refers to the percentage of capital (money) at work in a business by type. There are two forms of capital: equity capital and debt capital. Each has its own benefits and drawbacks and a substantial part of wise corporate stewardship and management is attempting to find the perfect capital structure in terms of risk / reward payoff for shareholders. How Debt and Equity Financing Differ In the academic world, it can be said that there is effectively no difference between debt and equity financing in valuing a company. However in debt
Capital Structure, Interest Rates and Credit Ratings
Prepared by Ece SARAÇOĞLU BILGI, MSc in International Finance INF 503 - Financial Economics and Interest Rates
December 2012
TABLE OF CONTENTS I. II. III. a) b) c) d) e) f) g) h) i) j) k) l) m) n) o) p) q) IV. V. Why Capital Structure Matters To Investments How Debt and Equity Financing Differ Choosing Between Debt and Equity Financing Process Ownership rights Rights over profit Ease of doing business Repayment Cost to company Future funding Choice of capital Obtained from Debt-to-equity ratio Requirements Advantages Disadvantages Application process Credit check Term Options Other The Debt-to-Equity Ratio
The Optimal Capital Structure a) Firm Value and Stock Value b) Capital Structure and the Cost of Capital How Financial Leverage Affects the EPS and ROE of a Firm How Interest Rates Affect the Demand for Debt and Equity Capital
VI. VII. VIII.
The Significance of Credit Ratings for Capital Structure a) Regulations on Bond Investment b) Information Content of Ratings c) Costs Directly Imposed on the Firm
IX. Credit Ratings in the Context of Existing Capital Structure Theories a) Tradeoff Theory b) Pecking Order Theory X. REFERENCES
2
Why Capital Structure Matters To Investments A firm’s capital structure is the relative proportions of debt, equity, and other securities that it has outstanding or how a firm pays for its assets. The term capital structure refers to the percentage of capital (money) at work in a business by type. There are two forms of capital: equity capital and debt capital. Each has its own benefits and drawbacks and a substantial part of wise corporate stewardship and management is attempting to find the perfect capital structure in terms of risk / reward payoff for shareholders. How Debt and Equity Financing Differ In the academic world, it can be said that there is effectively no difference between debt and equity financing in valuing a company. However in debt
References: 1. Capital Structure and Corporate Financing Decisions (Theory, Evidence, and Practice) TheoH. Kent Baker and Gerald S. Martin 2. Using the Debt-to-Equity Ratio Philip Durell 3. Credit Ratings and Capital Structure Darren J. Kisgen 4. Corporate Finance, Second Edition Berk/DeMarzo 5. Capital Structure, Debt Maturity and Stochastic Interest Rates Nengjiu Ju and Hui Ou-Yang 6. Capital Structure, Interest Coverage & Optimal Credit Ratings NERA (National Economic Research Associates) 7. The Debt-Equity Trade Off: The Capital Structure Decision Aswath Damodaran 8. Corporate Capital Structure: The Theory and Practice of Corporate Capital Structure Deutsche Bank 9. Determinants of Corporate Capital Structure: Evidence from European Countries Antonios Antoniou, Yilmaz Guney and Krishna Paudyal 10. Optimal Capital Structure and the Term Structure of Interest Rates Chris Downing and Xin Wang 11. Capital Structure Lecture R2 14