1010271-Cor-10_v3 - Equity Derivatives and Related Products...

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Unformatted text preview: Equity Derivatives and Related Products Class 10: Tax Considerations / Hedging and Monetizing Concentrated Stock Mark Zurack November 9, 2010 0903270-Col-MBA-18-19 2 Class Objectives To complete our discussion on Convertible Bonds To explain how the different Equity Derivatives products we have discussed are taxed To explain additional tax considerations related to hedging single stocks To show how to tax efficiently buy equity market exposure To demonstrate how derivatives can be used to tax efficiently short stock and harvest capital losses To discuss what types of investors hold concentrated stock positions and why they should diversify To describe what restricted stock is and how it relates to single stock hedging To compare the pay-offs of traditional hedging strategies for single stocks To introduce strategies that hedge and monetize a stock 1010271-Cor-10 0903270-Col-MBA-18-19 3 Key Characteristics of Convertibles Conversion Ratio Convertible bond holders have the right (but not the obligation) to exchange their bond and forfeit future interest payments and redemption of principal, usually at any time (i.e., American-style exercise), in return for a pre-determined number of shares. The number of shares receivable is known as the conversion ratio Parity Parity is the equity market value that holders of a convertible bond would receive upon conversion Equity Premium Equity premium is the value paid for a convertible above parity (typically stated either in bond points or as a percentage of parity) Fixed-Income Value Fixed-income value is the estimated value of a convertible ignoring its convertibility features (i.e., the value of the security as a straight bond) 1010270-Cor-9 0903270-Col-MBA-18-19 4 Key Characteristics of Convertibles Five year TXN 4.25% convertible bonds had a conversion ratio of 22.5 and were trading at $99.50 versus a stock price of $15.00. If TXN issued a five year 4.25% straight bond, it would have traded at $90 for a yield to maturity of 6.63%. TXN pays a dividend of $0.09 per year What is parity? At what price would investors convert the bond into stock at maturity What is the current equity premium? What is the fixed-income value? Would you expect this bond to rally much as TXNs stock price rallies? How would you measure the implied volatility of the call option?...
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This note was uploaded on 01/25/2011 for the course NBA 6940 at Cornell University (Engineering School).

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1010271-Cor-10_v3 - Equity Derivatives and Related Products...

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