Theory and Practice of Optimal Capital Structure

Stanley Myint and Fabrice Famery

Contents

Foreword

Introduction

1.

Theory and Practice of Corporate Risk Management

2.

Theory and Practice of Optimal Capital Structure

3.

Introduction to Funding and Capital Structure

4.

How to Obtain a Credit Rating

5.

Refinancing Risk and Optimal Debt Maturity

6.

Optimal Cash Position

7.

Optimal Leverage

8.

Introduction to Interest Rate and Inflation Risks

9.

How to Develop an Interest Rate Risk Management Policy

10.

How to Improve Your Fixed-Floating Mix and Duration

11.

Interest Rates: The Most Efficient Hedging Product

12.

Do You Need Inflation-linked Debt?

13.

Prehedging Interest Rate Risk

14.

Pension Fund Asset and Liability Management

15.

Introduction to Currency Risk

16.

How to Develop Currency Risk Management Policy

17.

Translation or Transaction: Netting Currency Risks

18.

Early Warning Signals

19.

How to Hedge High Carry Currencies

20.

Currency Risk on Covenants

21.

Optimal Currency Composition of Debt 1: Protect Book Value

22.

Optimal Currency Composition of Debt 2: Protect Leverage

23.

Cyclicality of Currencies and Use of Options to Manage Credit Utilisation

24.

Managing the Depegging Risk

25.

Currency Risk in Luxury Goods

26.

Introduction to Credit Risk

27.

Counterparty Risk Methodology

28.

Counterparty Risk Protection

29.

Optimal Deposit Composition

30.

Prehedging Credit Risk

31.

xVA Optimisation

32.

Introduction to M&A-related Risks

33.

Risk Management for M&A

34.

Deal-contingent Hedging

35.

Introduction to Commodity Risk

36.

Managing Commodity-linked Revenues and Currency Risk

37.

Managing Commodity-linked Costs and Currency Risk

38.

Commodity Input and Resulting Currency Risk

39.

Offsetting Carbon Emissions

40.

Introduction to Equity Risk

41.

Hedging Dilution Risk

42.

Hedging Deferred Compensation

43.

Stake-building

In this chapter we will give a brief overview of the theory of optimal capital structure of the enterprise, and how companies apply it in practice. As in Chapter 1, there is a significant gap between theory and practice. In the broadest sense, finding the optimal capital structure means determining what proportion of the firm’s capital should come from various sources. For instance:

    • what is the optimal split of equity versus debt (ie, optimal leverage)?

    • what is the optimal split of debt between bank loans and bonds?

    • what is the optimal split of debt between secured and unsecured? and

    • should the company have any convertible bonds or other hybrid sources of capital?

Various forms of capital have different expected cashflows, different treatment upon default of the company, different tax and accounting treatment and different implications in terms of the relationship with the stakeholders of the company. The vast majority of academic research is devoted to the first question (optimal leverage), and we shall now focus our attention on this issue.

PLAN OF THE CHAPTER

We start by summarising the main steps we take and our main conclusions

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