Question

Dividend-paying firms with no investment opportunities violate which of following assumptions of “perfect capital markets”?

Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.

A) There are no taxes, transaction costs, or issuance costs associated with security trading.

B) A firm’s financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them.

C)Exactly two of the above.

D)Exactly three of the above.

E)All of the above.

F)None of the above.

Answer 1

To understand this we first need to know about "Perfect Capital Market" and its assumptions.

Perfect Capital Markets : A market is said to be perfect when the below three conditions satisfy:

(i). Investment firms and investors can trade same securities at competitive prices which is equal to the present value of the all future cash flows.

(ii). There are no taxes, transaction costs or issue cost with the trading of the security involve.

(iii). So, if a firm take decisions about the financing of the firms it doesnot change the cash flows generated by its investments.

So, these are the assumptions of "perfect capital market", and the firms paying dividend and having no future investment opportunities violate these assumptions.

So, all the three statements regarding "perfect capital markets" are true.

Hence, Option (D) is correct.