Professional Documents
Culture Documents
Convertibles,
Exchangeables,
and Warrants
22-1
22-2
Convertibles, Exchangeables,
and Warrants
22-3
Convertible Securities
Value of Convertible
Securities
Exchangeable Bonds
Warrants
Derivative Security
Derivative Security -- A financial contract
whose value derives in part from the value and
characteristics of one or more underlying
assets (e.g., securities, commodities), interest
rates, exchange rates, or indices.
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Convertible Security
Convertible Security -- A bond or a preferred
stock that is convertible into a specified
number of shares of common stock at the
option of the holder.
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Convertible Security
Conversion Price -- The price per share at
which common stock will be exchanged for a
convertible security. It is equal to the face
value of the convertible security divided by
the conversion ratio.
ratio
Conversion Ratio -- The number of shares of
common stock into which a convertible
security can be converted. It is equal to the
face value of the convertible security divided
by the conversion price.
22-6
Conversion Example
FunFinMan, Inc., has an issue of 8%,
$100 par value preferred stock
outstanding. The security has a
conversion price of $30 per share.
What is the conversion ratio?
Conversion Ratio
= $100 par value / $30 conversion price
= 3.33 shares
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over time.
Example:
The
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Conversion Value
Conversion Value -- The value of the
convertible security in terms of the common
stock into which the security can be
converted. It is equal to the conversion ratio
times the current market price per share of the
common stock.
For example, if the market value per share of common
stock in FunFinMan, Inc., were trading at $42 per
share,
share then the conversion value is:
3.33 shares x $42 = $140 per share of preferred stock
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Premium Over
Conversion Value
Premium Over Conversion Value -- The
market price of a convertible security
minus its conversion value; also called
conversion premium.
For example, if the market value per share of
preferred stock in FunFinMan, Inc., were
trading at $154 per share,
share then the conversion
premium is:
$154 - $140 = $14 premium per share of
preferred stock (or a 10% premium).
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22-11
Use of
Convertible Securities
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Forcing or
Stimulating Conversion
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Convertible Value
Convertible Bond Value = Straight Bond
Value + Option Value
Volatility
Decreases
Increases
Suggests
option value
22-14
VSB =
I/2
(1 + i/2)1
2*n
t=1
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I/2
(1 + i/2)
I/2
(1 + i/2)2
+ ... +
I/2+F
(1 + i/2) 2*n
F
(1 + i/2)2*n
i/2, n
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Relationships
Among Premiums
22-18
Market
value line
Value of Convertible Security
Convertible
security
value
Premium
Straight
bond value
Relationships Among
Premiums -- Summary
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Exchangeable Bond
Exchangeable Bond -- A bond that allows the
holder to exchange the security for common
stock of another company -- generally, one in
which the bond issuer has an ownership
interest.
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Valuation of
an Exchangeable
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Warrants
Warrant -- A relatively long-term option to
purchase common stock at a specified
exercise price over a specified period of time.
Warrants are employed as sweeteners:
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Warrant Features
22-23
Example of
Exercise of Warrants
FunFinMan, Inc., is currently financed entirely
with common stock. The firm is composed
of $10 million in common stock ($5 par
value) and $20 million in retained earnings.
The company is considering issuing $20
million of 8%, 20-year debentures including 1
warrant per bond that can be converted into
5 shares of common stock at an exercise
price of $40 per share. How will this impact
the capitalization of the firm?
22-24
Example of Exercise
of Warrants (in millions)
Before
After*
Financing Financing
Debentures
Common stock ($5 par)
Additional paid-in capital
Retained earnings
Shareholders equity
Total Capitalization
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$ 0
10
0
20
$ 30
$ 30
$ 10
10
0
20
$ 30
$ 40
Example of Exercise
of Warrants (in millions)
Before
After*
Financing Exercise
Debentures
Common stock ($5 par)
Additional paid-in capital
Retained earnings
Shareholders equity
Total Capitalization
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$ 0
10
0
20
$ 30
$ 30
$ 10
10.5
3.5
20
$ 34
$ 44
Valuation of a Warrant
max [ (N)(Ps) - E, 0]
N = number of shares per
warrant
Ps = market price of one
share of stock
E = exercise price
associated with the
purchase of N shares
Warrant Value
Theoretical value of a
warrant:
Market
value line
Exercise
price
Theoretical
value line
45o
Example of the
Valuation of a Warrant
Theoretical value of a
warrant:
N = 1,
1 Ps = $10 , E = $5
max[(
max 1)($10)$10 $5,
$5 0] = $5
N = 1,
1 Ps = $15 , E = $5
max[(
max 1)($15)$15 $5,
$5 0] =$10
Warrant Value
max [ (N)(Ps) - E, 0]
$5
$10
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