FIN3004_lecture12.ppt - Lecture 12 Hybrid Financing...

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1 Lecture 12 Hybrid Financing: Preferred stock, Warrants, and Convertibles
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2 Learning Outcomes Understand how warrants and convertible bonds are similar to call options Understand how warrants and convertible bonds differ from call options Understand why corporations would issue either warrants or convertible bonds
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Lecture Outline Warrants Convertibles Reasons for Issuing Warrants and Convertibles Why are Warrants and Convertibles Issued? Conversion Policy
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4 Warrants Warrants are call options that give the holder the right, but not the obligation, to buy shares of common stock directly from a company at a fixed price for a given period of time. Warrants tend to have longer maturity periods than exchange traded options. Warrants are generally issued with privately placed bonds as an equity kicker. Warrants
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5 Warrants Warrants are also combined with new issues of common stock and preferred stock and/or given to investment bankers as compensation for underwriting services. In this case, they are often referred to as a Green Shoe Option. Warrants
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6 Warrants The factors that affect call option value affect warrant value in the same ways. Stock price + Exercise price Interest rate + Volatility in the stock price + Expiration date + Dividends Warrants
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7 The Difference between Warrants and Call Options When a warrant is exercised, a firm must issue new shares of stock. This can have the effect of diluting the claims of existing shareholders. Warrants
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8 Dilution Example Imagine that Mr. Armstrong and Mr. LeMond are shareholders in a firm whose only asset is 10 ounces of gold. When they incorporated, each man contributed 5 ounces of gold, then valued at $300 per ounce. They printed up two stock certificates and named the firm LegStrong, Inc.. Warrants
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9 Dilution Example Suppose that Mr. Armstrong decides to sell Mr. Mercx a call option issued on Mr. Armstrong s share. The call gives Mr. Mercx the option to buy Mr. Armstong s share for $1,500. If this call finishes in-the-money, Mr. Mercx will exercise, Mr. Armstrong will tender his share. Warrants
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10 Dilution Example Nothing will change for the firm except the names of the shareholders.
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