Some uncertainties often surround the process of making financial decisions in an
organisation (Brealey, Myers and Allen, 2010). This is because these decisions
will entail making decisions by deciding on the optimal capital structure. In
making of such decisions, management is expected to develop a capital structure
that achieves the objective of maximising the firm value by considering the
different sources of funds to the organisation. The benefits and drawbacks
associated to the different sources of finance have motivated the proposition
of different capital structure theories as researchers try to establish
different approaches that managers can utilise while making the financial
decisions (Aziz and Merville, 2017). According to Sharma (2016), capital structure represents the
proportion between the different long-term sources of finance in the capital of
a company. The long-term sources of finance as used in this context are
classified as either borrowed funds or proprietor’s funds. Borrowed funds are
made up of long-term debts such as loans, bonds and debentures. The
proprietor’s funds on the other hand, include the equity capital, preferred
stock and the retained earnings. The potential benefits and drawbacks of each
source of capital is what presents the management of a firm with tough
decisions of establishing the perfect capital structure balance while
considering the risk/reward payoff for the company’s shareholders (Bierman,
2003). Furthermore, research by Modigliani and Miller (1958) established that
the concept of capital structure is immaterial when evaluated in light of
explicit restrictive assumptions. Since then, researchers working under less
restrictive assumptions have managed to agree that an optimal choice of capital
structure does exist. However, the mystery on these finding remains the
researchers has not been able to agree on what that optimal capital structure
should be. This paper will explore
the relationship between the corporate capital structure and the introduction
of credit derivatives to the international financial markets.