medium · FRM Part 1 Foundations of Risk Management
A risk professional is assessing the 'Hedging Paradox.' According to the Modigliani-Miller theorem, why would hedging be value-neutral for a firm in a frictionless market?
- The costs of financial distress are always higher than the benefits of hedging.
- Tax schedules are typically linear, making volatility irrelevant for tax bills.
- Hedging always reduces the firm's expected return along with its risk.
- Shareholders can diversify risks on their own at the same cost as the firm.
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