Lecture Note - Corporate Finance Lecture Note 6 1 Lecture Note 6 Warrants and Convertibles and Other Hybrid Financing Contracts Corporate Finance

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Unformatted text preview: Corporate Finance Lecture Note 6 1 Lecture Note 6 Warrants and Convertibles and Other Hybrid Financing Contracts Corporate Finance Lecture Note 6 2 What is in This Note? • Overview of Valuations of Warrants and Convertible Bonds • Overview of the reasons for using Warrants and Convertible Bonds • Overview of Other Hybrid Financing Contracts • Reference: Chapter 24 of RWJJ, Chapter 25 of BMA Corporate Finance Lecture Note 6 3 Valuations of Warrants Corporate Finance Lecture Note 6 4 Roadmap Understand how warrant is similar to call options Understand how warrant is differ from call options Warrant Pricing Corporate Finance Lecture Note 6 5 Warrants • If a firm issues a call option on its own stock, it is known as a warrant. • When a warrant is exercised, the warrant‑holder receives a share worth more than the strike price. This is dilutive to other shareholders. • The question is how to value a warrant, and how to value the equity given the existence of warrants. Corporate Finance Lecture Note 6 6 Differences between warrants and standard call options • When warrants are issued, the purchase price is received by the firms and increases the firm value. • When warrants are exercised, the exercise price is received by the firm and increases the firm value. • When warrants are exercised, new shares are issued by the firms. • In contrast, when standard call options are exercised, there is no change in the number of shares outstanding, just the call option seller transfers the existing shares to call option buyers. Corporate Finance Lecture Note 6 7 Warrants • Suppose – a firm has n shares outstanding, – the outstanding warrants are European, on m shares, with strike price K , and – the asset value is A – Assume the firm has only stock and warrants . • At expiration, if the warrant‑holders exercise the warrants, they pay K per share and receive m shares. Corporate Finance Lecture Note 6 8 Warrant Pricing • After the warrants are exercised, the firm has assets worth A + mK . Thus, exercised warrants are worth • The warrant can be valued by using the Black‑Scholes formula: ( , , , , , ) n A BSCall K r t n m n σ δ + ( ) A mK n A K K n m n m n +- = - + + Dilution correction factor Corporate Finance Lecture Note 6 9 In-class Exercise • Assume there are 20 shares outstanding and the firm has assets worth A=$100. σ =30%, and r=8%. Compute the value of the warrants for warrants on 2 shares expire in 5 years and have a strike price of $15. • Dilution correction factor=20/(20+2)=0.909 • Value of warrant per share =0.909*[5*N(d 1 )- 15N(d 2 )*e-0.08*5 ]=0.3209, • The total value of warrant=2*0.3209=$0.6418 Corporate Finance Lecture Note 6 10 o & o & o & o &&& o && Of ¡ ¶ “ A& o && o && Of ¡ ¶ “ o && o &&& 04506 o 72 0.08 o 12.40 o 6.94% 33.75% 13.26 1.020 2007/11/ 16 04514 o D4 0.30 o 115.00 o 0.77% 60.32% 115.88 0.057 2007/11/ 16 04533 o A4 2.80 o 99.50 o 38.54% 74.43% 71.82 0.100 2007/11/...
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This note was uploaded on 04/18/2010 for the course FINANCE 936116531 taught by Professor Wuyiling during the Spring '10 term at Nashville State Community College.

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Lecture Note - Corporate Finance Lecture Note 6 1 Lecture Note 6 Warrants and Convertibles and Other Hybrid Financing Contracts Corporate Finance

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