Evolution of Financial Theory

a. The concept of perfect capital markets In general, perfect capital markets have the following characteristics:
- There are no transaction fees
- There is no tax
- There are quite a number of buyers and sellers
 - Both individuals and companies have the same ability to access markets
- There is no information fee so everyone has the same information
- Everyone has the same hope
- There are no costs associated with financial difficulties
It is clear that not all of these assumptions apply to the real world, however a theory should not be judged by reality or its assumptions, but judged by how much the theory is consistent with actual behavior.

b. Analysis of discounted cash flow (discounted flow analysis)
The process of assessing future cash flows is called discounted cash flow (DCF) analysis. The basic concept of DCF is the time value of money.

c. Capital structure theory from Modigliani and Miller (capital structure theory)
Modern financial theory (1958) MM concludes that the value of a company depends solely on future income streams (future earnings streams). And therefore the value does not depend on the capital structure (the ratio of debt and own capital). MM uses very strict assumptions, including perfect capital market assumptions. Because one important assumption is the absence of taxes, this model is called the MM model without tax. Capital structure theory (1963), MM omits assumptions about the absence of taxes. With the corporate income tax, debt can save taxes paid (because debt raises interest payments which reduce the amount of income taxable). This model is called the MM model with tax.
Tax savings financial cost trade off theory (improvement of the MM model with tax), because debt generates tax savings but also raises the cost of financial difficulties. In general this modified MM model teaches:
- Being in debt is good.
- Owe too much is not good
- There is an optimal amount of debt for each company

d. Dividend theory from Modigliani and Miller (dividend theory)
MM also analyzes the impact of dividend policy on firm value, in addition to perfect capital market assumptions, also includes
- The company's capital budgeting policy is not influenced by dividend policy.
- All investors behave irrationally.
Based on these assumptions they concluded that the dividend policy did not affect the value of the company.

e. Portfolio theory and capital assets pricing model (CPAM)
The main lesson from portfolio theory is that in general, risk can be reduced by combining several types of risky assets rather than holding only one type of asset, the implications of this theory are:
- Investors must form a portfolio (diversify) to reduce risk.
- The risk of an individual asset must be measured based on its contribution to the risk of a well diversified portfolio.
Although portfolio theory teaches investors how to measure risk, this theory does not show the relationship between risk and the level of profit that is implied. CAPM (William Sharpe, John Lintner and Jan Moissin), shows that the level of profit that is implied in a risky asset is a function of three factors, namely:
 - Risk-free profit rate
- The level of profit implied by a portfolio with an average risk (market portfolio)
- Volatility of the rate of return of risky assets to the level of market portfolio profits.
CAPM is based on perfect capital market assumptions plus a number of other assumptions. CAPM has real implications on the determination of the company's capital costs as well as determining the level of profit that is implied in an individual project within the company.

f. Option pricing theory
An option is the right to buy (sell) an asset at a predetermined price for a specified period of time.
This theory offers a price or call valuation premium model and put option. The implication of this theory is that developing markets for options, especially options for financial assets. This theory also helps to understand the valuation of securities that have option properties such as warrant and convertible bonds.