FIN 620-session9 agenda

FIN 620-session9 agenda - FIN 620 Capital Markets,...

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FIN 620 Capital Markets, Institutions, and Long-Term Financial Management Session 9  Agenda 1. Lecture Notes/Comments 2. Power points 3. Self Study Materials 4. Homework 5. Group Project 6. Class Discussion 1. Lecture Notes/Comments RJW, Chapters 24, 25 Warrants A Warrant is a security issued by firms that gives the holder the right, but not the obligation, to purchase the common stock directly from the company at a fixed price for a given period. May be used as sweeteners or equity kickers – warrants issued in combination with privately placed loans or bonds, public issues of bonds, and new stock issues. Similarities between warrants and options: 1. Both are American call options on the equity of the firm. 2. Both are usually protected against stock dividends and stock splits. 3. Neither is protected against cash dividends. 4. The values of both are affected in the same way from changes in stock price, exercise price, etc. The Difference between Warrants and Call Options 1. Exercise period of a warrant is usually several years. 2. Warrants are issued by the firm. Options are issued by individuals. 3. When a warrant is exercised the firm receives the exercise price from the investor, and the firm simultaneously issues new shares. The last two differences are important because a warrant is a contract between the firm and a warrant-holder while an option is a contract between individuals. Further, the exercise of warrants causes an increase in the number of outstanding shares , whereas the exercise of “normal” calls does not. When the number of shares increases, the EPS will decrease, all else equal. Because of the dilution impact of warrants, firms with a large number of warrants or convertible securities outstanding report earnings on a diluted basis.
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How the Firm Can Hurt Warrant Holders: To reduce the firm value, existing owners could liquidate assets and pay out dividends, thereby keeping warrants out of the money. Warrant Pricing and the Black-Scholes Model: As warrants are exercised, dilution occurs because the firm's assets and profits are spread over a larger number of shares. As share price rises above the exercise price, warrants will be converted into common stock , thus diluting the proportional ownership of each share in the company. Therefore, outstanding warrants have a dampening effect on stock price appreciation. The Black-Scholes Option Pricing Model must be restated for use with warrants . In general, the gain from a warrant is always less than the gain from an otherwise-identical option, and the relationship is: Convertible Bonds A Convertible bond is a bond that may be converted into a fixed number of shares of common stock on or before the maturity date. Thus, it is similar to a bond with warrants. The biggest
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FIN 620-session9 agenda - FIN 620 Capital Markets,...

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