Tool Kit for Hybrid Financing: Preferred Stock, Warrants, and Convertibles
A firm has sold 150,000 shares of $100 par value perpetual preferred stock (the total issue is $15 million).
preferred stock has a stated annual dividend of $12 per share.
What is the dividend yield?
Par value =
INITIAL MARKET PRICE OF A BOND WITH WARRANTS
Price of the 8% coupon bonds
Price paid =
Total funds to be raised=
Total number of bonds=
Warrants per bond =
Total no. of warrants =
In this model, we will examine three sources of long-term capital: preferred stock, warrants, and convertibles. Preferred
stock is a hybrid security that represents a cross between debt and common equity.
Warrants are derivative securities used
Lastly, convertible securities are hybrids between debt and warrants.
PREFERRED STOCK (Section 21.1)
Commonly, preferred stock has a par value of $25 or $100.
A preferred dividend is indicated as a percentage of par, or as
dollars per share.
Since preferred stock pays a perpetual dividend, its value is derived as the preferred dividend divided by
the cost of preferred stock.
Preferred stock's dividend yield, like common stock is the dividend paid divided by the value of
WARRANTS (Section 21.2)
A warrant is a certificate issued by a company which gives the warrant holder the right to buy a stated number of shares of
the company's stock at a specified price for some specified length of time.
Such warrants are called long-term call options,
because they offer investors the opportunity to buy the firm's common stock at a fixed price, regardless of how high the stock
This option offsets a low interest rate on a bond and can make a low-yield bond/warrant package more appealing
A corporation decides to issue 20 year bonds to fund a $50 million expansion.
If they were to issue a straight bond package,
the bonds would carry a 10% coupon rate, however the current bond proposal calls for an 8% coupon and stock warrants.
Thus, investors will be paying $1,000 in return for the 8% coupon, 20-year bond and 20 warrants (the strike price of the
warrants is $22).
What is the implied value of each warrant?
To find the implied value of each warrant, we must first determine the total value of this call option.
The value of the option
can be determined as the difference in price between the 8% coupon bond being issued, discounted by 10%. We use a 10%
discount rate, because it is the true measure of the firm's cost of debt, and it accurately reflects the riskiness of these bonds.