Some uncertainties often surround the process of making financial decisions in anorganisation (Brealey, Myers and Allen, 2010). This is because these decisionswill entail making decisions by deciding on the optimal capital structure. Inmaking of such decisions, management is expected to develop a capital structurethat achieves the objective of maximising the firm value by considering thedifferent sources of funds to the organisation.
The benefits and drawbacksassociated to the different sources of finance have motivated the propositionof different capital structure theories as researchers try to establishdifferent approaches that managers can utilise while making the financialdecisions (Aziz and Merville, 2017). According to Sharma (2016), capital structure represents theproportion between the different long-term sources of finance in the capital ofa company. The long-term sources of finance as used in this context areclassified as either borrowed funds or proprietor’s funds. Borrowed funds aremade up of long-term debts such as loans, bonds and debentures. Theproprietor’s funds on the other hand, include the equity capital, preferredstock and the retained earnings.
The potential benefits and drawbacks of eachsource of capital is what presents the management of a firm with toughdecisions of establishing the perfect capital structure balance whileconsidering the risk/reward payoff for the company’s shareholders (Bierman,2003). Furthermore, research by Modigliani and Miller (1958) established thatthe concept of capital structure is immaterial when evaluated in light ofexplicit restrictive assumptions. Since then, researchers working under lessrestrictive assumptions have managed to agree that an optimal choice of capitalstructure does exist. However, the mystery on these finding remains theresearchers has not been able to agree on what that optimal capital structureshould be.
This paper will explorethe relationship between the corporate capital structure and the introductionof credit derivatives to the international financial markets.