2. 1.Capital markets are said to be perfect if they
satisfy three conditions:
a.Investors and firms can trade the same set of
securities at competitive market prices equal to the
present value of their future cash flows.
b.There are no taxes, transaction costs, or issuance
costs associated with security trading.
c. A firm’s financing decisions do not change the cash
flows generated by its investments, nor do they reveal
new information about them.
3. Roles of perfect capital market
assumption
• Clearly, most of these assumptions do not hold in the real world-
taxes and brokerage costs exist, individuals often do not have the
same access to markets as corporations, managers often have more
information about their firms’ prospects than do outside investors
and so on. Still, a theory should not be judged on the reality of its
assumption, but rather on how consistent its predictions are with
actual behavior. If a theory seems reasonable and is consistent with
behavior, then the theory will generally be accepted, regardless of
the realism of its assumption. Often the assumptions do not limit
the ability of the theory to explain real-world phenomena.
• For example, although taxes certainly exist, there may be enough
tax-exempt institutions with sufficient capital to produce the results
predicted by a theory that assumes zero taxes.
4. A perfectly competitive market has
following assumptions:
• Large Number of Buyers and Sellers:
ADVERTISEMENTS:
• Homogeneous Products:
• No Discrimination:
• Perfect Knowledge:
• Free Entry or Exit of Firms:
• Perfect Mobility:
• Profit Maximization:
• No Selling Cost:
5. • In “perfect capital markets,” no buyer or seller (or
issuer) of securities is large enough for his
transactions to have an appreciable impact on
the then ruling price. All traders have equal and
costless access to information about the ruling
price and about all other relevant characteristics
of shares. No brokerage fees, transfer taxes, or
other transaction costs are incurred when
securities are brought, sold, or issued, and there
are no tax differentials either between
distributed and undistributed profits or between
dividends and capital gains.
6. • In a perfect capital market, the reason for
shareholder’s indifference to different patterns of
dividend payments is that the effect of dividend
payments on shareholders wealth is offset exactly
by other means of financing such as a new share
issue or a new debt issue.
• A company may decide to pay a dividend and
make a new share issue of the same amount in
order to finance the company’s proposed
investments.
