Capital structure?

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The Capital Structure of a corporation is the way in which that entity finances itself -- by some combination of equity sales, equity options, bonds, and loans.

Is there an optimal capital structure, one that allows a corporation to get the most bang for its bucks? If so, what is that structure and on what factors does it depend? These are important questions for the discipline of financial economics.

Arbitrage

Similar questions are also the concern of a variety of speculator known as a capital-structure arbitrageur, see arbitrage.

A cap-structure arb looks for opportunities created by the differential pricing of different instruments issued by the same corporation. Consider, for example, traditional bonds and convertible bonds. The latter are bonds that are, under contracted-for conditions, convertible into shares of equity. The stock-option component of a convertible bond has a calculable value in itself. The value of the whole instrument should be the value of the traditional bonds plus the extra value of the option feature. If the spread, the difference between the convert and the non-convert bonds gets too large, than a cap-structure arb will bet that it will converge.

External links

• The Corporate Financing Cube

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