Capital Structure looks at how a firm finances the assets they have. In other words, the mix of debt and equity that a firm has. If there is one thing you learn in all of this: Debt makes good times great and bad times horrible.
An introduction to capital structure for my Corporate Finance classes. I made this video that serves as a good introduction to the topic. Key Points: 1. Debt makes good times Great, and bad times horrible. 2. In a perfect world (Modigliani and Miller's world) capital structure does not matter. 3. We don't live in a perfect world, so capital structure does matter. 4. Capital structure can not make a bad firm into a good firm. Operations are still more important, but capital structure can make influence a firm's value positively and negatively.Edit Remove Move
Capital Structure "class" II--a continuation of the discussion that looks at some of the downside of debt. (NOTE: Apple has issued debt since this was recorded.)Edit Remove Move
Capital structure is the mix of debt and equity. So to begin off, it makes sense to remember for a second how we measure this and why (and probably how) capital structure matters.
To examine capital structure there are two basic ways that people use. The first is in raw aggregate totals. the second is in some ratio. As an example of each, consider the Federal Reserve quarterly Financial Flow of funds report that shows total debt broken down in a myriad of ways. Please take about 10 minutes and look over a recent one (this is from the first quarter of 2013) Looking further into the report you can see total debt by year, growth rates, as well as aggregate totals.
Firms generally use ratios (remember leverage ratios) to measure their debt. So taking a few minutes to review common leverage ratios is probably a good idea:
Long term Debt to Total Assets
Debt to Equity
Times Interest Earned (TIE)
All of these go by different names and can be confusing for that reason, but overall should be pretty straight forward.
Until my website is back and functioning, here is a review of financial ratios (including leverage ratios) from Pamela Drake of JMU.
Securities Industry and Financial Markets Association (SIFMA) gathers data from the US and shows issuance and trading of debt. While this is a fascinating page, and likely could make up most of a class period looking at it, please look for a few key things: Notice how debt is overall increasing. A great essay question is why do you think this is happening. Is it happening equally. Look at this and the Fed's numbers from above. What do you see before and after the "great recession"? How have individuals behaved? Corporations? Municipalities? and the Federal Government?Edit Remove Move
Just to get a further feel for how these ratios work and move around, I will give a few different examples of their use. They are all pretty short. We will start off with one from Paul Kedrosky via Seeking Alpha: "For an upcoming presentation I have been looking at changes in the global debt to equity ratio over the last decade or so. Specifically, I've been analyzing the ratio of total global debt - corporates plus government issuance, both domestic and international - versus total world equity market capitalization over the period." BTW I highly recommend you follow Paul on Twitter. Intelligent and interesting even if not always on finance. (https://twitter.com/pkedrosky)Edit Remove Move
Firms in the same industry have quite a bit in common. What can you see about the debt levels at these industries? Here are some general items: <br><br><br><ul><li>Riskier industries (high business risk) generally (but not always) have lower financial leverage.</li><li> Firms whose assets make better collateral generally (but not always) have higher financial leverage. <br></li><li>Although many people use book values when calculating ratios, <b>market values are much more timely and should be the default variable to be used unless there are unusual circumstances</b> that make a case for book values (example an illiquid market etc).</li></ul><br><br><br> BTW Aswath is a financial genius. I HIGHLY recommend reading as much as you can from him (especially if you are in SIMM) Follow him on twitter here: <a rel="" target="" href="https://twitter.com/AswathDamodaran">https://twitter.com/AswathDamodaran</a> <br>Edit Remove Move
Ok, so I am not holding you responsible for all of these, but they are so well done, I had to at least offer them to you. Christine, great job!Edit Remove Move