Chapter 7. Arbitrage and the (Ir)Relevance of Capital Structure
Looking back now, perhaps we should have put more emphasis on the other, upbeat side of the “nothing matters” coin: showing what doesn’t matter can also show, by implication, what does.
—Merton H. Miller1
One of the earliest examples of arbitrage-based financial reasoning is the Nobel Prize-winning Modigliani-Miller (M&M) capital structure theory.2 This chapter considers the role of arbitrage in assessing the relevance of capital structure decisions in the context of the M&M model. In so doing, the chapter shows how the firm and the securities it issues to finance its operations may be viewed as put and call options. Furthermore, it applies the put-call parity framework developed ...
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