040645 EK KFK CF: Financial Policy (E) (2009W)

The main responsibilities of financial officers are to raise capital from the financial markets and to invest these funds in projects with positive net-present-values. In this course we mainly deal with the former responsibility, that is, with the question of optimal capital structure, optimal dividend policy and optimal corporate risk management. (The course Valuation deals with the second aspect, namely optimal capital budgeting decisions, mergers and acquisitions etc.) We start with an analysis of dividend policy. First, we demonstrate that in perfect capital markets, firm value would not be affected by dividend decisions. We proceed by identifying the most important market imperfections which make dividend policy relevant. In particular, we will analyze the effect of taxes, transactions costs and asymmetric information.

We then focus on firms' capital structure decisions. Again we start with an analysis in perfect capital markets and then identify the most important market imperfections. Besides taxes, we will focus extensively on the effect of conflicts of interest between management and shareholders and between shareholders and bondholders on the optimal choice of capital structure. We conclude our discussion of optimal capital structure by analysing the effect of bankruptcy costs and costs of financial distress on the optimal choice of a financial structure.

Finally, we address the issue of corporate risk management. The discussion will initially focus on market imperfections which make hedging necessary. In a second step we will explore methods which can be used in implementing corporate risk management systems. In particular we will focus on the measurement of exposure and on the application of the hedging techniques for interest rate risk and operational risks.