lecture1 - Page 1 of 5 Help Week 1: Hybrid Securities,...

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Hybrid Financing and Corporate Dividends Introduction | Warrants | Convertible Securities | Dividends and Stock Repurchase | Investor Preferences | Gordon Model | Dividend Irrelevance Theory | Bird - in - the - Hand Theory | Tax Preference Theory | Signaling Hypothesis and the Clientele Effect | Dividend Payout Theory | Stock Splits | Stock Dividends | Stock Repurchase Chapter 19 reintroduces us to our old friend, preferred stock, covered in FI515; it provides a brief yet succinct overview of this hybrid (stock with debt attributes). Read thoroughly for an excellent review. Another form of hybrid security is the warrant. A warrant is an option (certificate) issued by a firm, which gives the holder the right to buy a stated number of shares of that firm's stock at a specified price for some specified period of time. Although certain market conditions will determine whether it is economically feasible, the warrant holder has the power to exercise the warrant at any particular time. Warrants are usually issued with long-term debt (detachable warrants) and are used as an incentive to attract investors to buy such debt at a lower coupon rate than would be required with straight debt (no attached warrants). Warrants are often referred to as a "sweetener" because they make a long-term debt issue attractive or more attractive to potential investors. All options have a cost involved. The buyer of a long-term debt issue with (detachable) warrants attached accepts a lower coupon rate (usually around two percentage points) on the debt with the difference (between what a straight debt issue would yield and the coupon rate on the debt issue with warrants) representing the cost of the option (warrants). All warrants have an exercise price; usually this exercise price remains constant for the life of the warrants involved. However, some issues of warrants have a stepped-up exercise price over their life; this feature motivates the warrant holder to exercise earlier (once it becomes economically feasible) at a lower exercise price (allowing the firm to receive the exercise proceeds, or dollars, discussed earlier). Using the bond valuation model, one can determine the initial value of warrants; this is important as all warrants, once issued with their underlying security (long-term debt in our example), can be detached and be either held or Week 1: Hybrid Securities, Corporate Dividends and Stock Buyback Strategies - Lecture Help Print This Page Introduction Warrants Page 1 of 5 5/4/2011 ..
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sold in the marketplace. The warrant exercise price is established (carved in stone) at the time the underlying security issue is put together. Assume the firm's common stock is then selling at $40 per share; it would be foolish for the firm's management (along with its investment banker) to establish an exercise price of $40. Why? Because the firm can command a higher exercise price. How high a price? Well, there are limits, and the acceptable market range is a
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This note was uploaded on 08/27/2011 for the course FI516 FI516 taught by Professor Fi516 during the Spring '11 term at Keller Graduate School of Management.

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lecture1 - Page 1 of 5 Help Week 1: Hybrid Securities,...

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