Question description
Need responses to the student post below 1. Modigliani-Miller Proposition II states that the required return on a firm’s
equity is positively related to the firm’s debt-equity ratio therefore, any
increase in the amount of debt in a firm’s capital structure will increase the
required return on the firm’s equity. Since MM proposition II deals with the
Weighted Average Cost of Capital (WACC) it states that as the proportion of debt
int the company’s capital structures increase, its return on equity to
shareholders increases in a linear fashion. The existence of higher debt levels
makes investing in the company more risky, so shareholders demand higher risk
premium on the company’s stock.
Under MM theory of perfect capital markets believes in the existence of
“perfect capital markets and assumes that all the investors are rational, they
have access to free information there are no
floatation or transaction costs and that the market is
frictionless. The only problem with this is in reality there is not such thing
as the “perfect market” unfortunately the more information investors have or
know the more they are going to find a way for it to favor them because
dishonesty will always play.2. Anything investable that is not a stock, a bond or cash is commonly referred
to as an alternative asset. Alternatives run the gamut from “real” assets like
commodities, farmland, and timber, to sophisticated debt structures, derivatives
contracts and partnership interests in privately-held businesses. Partnerships
that involve publicly-traded securities but allow the manager to hedge by
selling short are also considered to be alternatives.
Alternatives are popular with institutional investors and wealthy individuals
because their returns are perceived to have a low correlation with those of the
stock and bond markets. Many consultants, chief investment officers and
advisers claim alternative investing combines higher returns with lower risk
relative to the stock market.
