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Double Leverage

A related dimension is that in certain situations, the arbitrage process (substituting corporate leverage by personal leverage) may not actually work. For instance, when an investor has already borrowed funds while investing in shares of an unlevered firm. If the value of the firm is more than that of the levered firm, the arbitrage process would require selling the securities of the overvalued (unlevered) firm and purchasing the securities of the levered firm. Thus, an investor would have double leverage both in personal portfolio as well as in the firm’s portfolio. The MM assumption would not hold trur in such a situation.

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