nba694class10 - Class 105"Hedging'ahd MonetiZing...

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Unformatted text preview: ' Class 105 "Hedging 'ahd MonetiZing Concentrated} Stock / ' ' ' Strategies for Corpdrations MaKk'Zur'ack _ . November 7, 2006 I Factors "to Consider: * Manage Risk I - Price Outlook ~_ Securities Laws 90 U MU”)? ---w~ . Monetize Poéition I o Need for Cash Today . Signaling Impact I Wk WW I/ . Diversify Exposure I . Taxes {'wfiv: inn/AU 5Qi“¢*‘- Voting Rights . _ I I ///I I -- Stock Price impact - Dividends i | : _ . . z 4 am 0609252'CDr-10 I A F , " 3’1" f‘ m . r , ’_ - ~ -- a W $23106" W . 30w; w; “i“??? .6)" f“? ‘5“?3‘? Pricing: Stock 5100 - E Infrequent Use Upfront cost scares most away Hedging Horizon 3 yrs I . 3-yr LIBOR 6% l A TM Implied I Volatility 40% .25 Delta Put-Call I Skew 10 P135 m Used reasonably often ‘ Investor not bearish, may not need downside ‘ protection on whole position n \ ,I a I Shareholder extracts value while holding the \ W67 ‘Wi I shares in a manner consistent with overall I _ l vamiw/ f _ QWQ} objectives ‘ is $3 \itw Not a straddle . \\:}'\E\K]z\u . \Ev Used very frequently ProVides maximum protection without triggering a constructive sale 3" v (a. Mpg l mm \ ‘ I l a Little to no upfront premium \i v ‘ a Stable asset to borrow from mm H “ _ 1 _, . «J , M j . - 1 r wwsaé~ 5‘ WWM‘QW WW ' rilmfi {:5 W W _- ~ i3) W i am and «onetization ~ a 9-1;“;le . _ , Investors who need iiQuidity for reinvestment or consumption . ti“ combine theirhed in transaction with a loan {a -- ‘ WOW 033W ' ' _ ' «a WW ' , @A $64 (data WV ‘ W“) 1’ - mariawm 'iiW ’ ' WW - 2"".Q‘vafiét i?.tsta.itl__yga;riable Share Emil-as (afi) %fl/m Ow WWWWWWW W W? 5% A packaged product which effectively‘conibines an equity collar 1‘ with a loan prOvlding.-the following payoff: 7_ _ ‘ Law ea omér‘ug a; . m *6?! “We . 5) .- ‘m _ Sitar/l2. , _ Investor receives upfront cash proceeds. “7 equivalent amount at ”expiration and pledgeis'the shares ‘ as collateral ' r Number of Shares 0r Cash .mountto be delivered 100%‘0f shares _ .Ol‘ _- ._ Equivalent-cash amount —— W xshares ' E i la Etc sh nt '-‘ Final price _ .91: ' ; qurva n a amou : .‘loor_levei+(F|nalprlce Cap level) xshares 93: A. Final price " _ _ ' Equivalent cash amount ‘ 0609252-C0r- 10 Underlying Stock: Floor Level: I Cap Level: Initial Stock Price: 1 # of Shares: Maturity: ' Proceeds upfront- 100°lo or $100 1400/0-03' $140 $100.00 «3; _ -" 500,000 ---’ 3 "years 82% of floor price, or$821 share or $41MM in total ..... :2» \e'" i. --':;m-W WM 590.60ng (J1 Number of Shares: 500,000 Total Proceeds: $41,000,000 (82%) . . - {gr}: 7g 9 Current MarketValue: $50,000.00!) ' ' 3Years I .3. N3, :7"! '3 HQ. 1, ' 4' '5 -' ‘- '- =J) {3311‘ . _ - $60 60% $30 $41 5 0.000 0 ‘ ,4 .- {34 M $70 70% $35 $41 500,000 0 g '42" ' 500,000 0 W 7 “ ° ., __________ '476.190 .4 14/0003 $110 $55 $41 454,545 45.455 3 Wi‘m r 14,; * . $115 $58 641 434,783 65.217 . ‘ r 4 WE; $60 941 416.667 83.333 1! ng ab 5" 7"” 663 341 400000 100.000 11V {0013 A. ‘ 384,615. 115.385 . ' . ~ . 370 370 129 630 . {71> ‘1 ' . 6414“": 363,07 0 ngw W 7,1 ‘ 150% $75 341 366.667 133.333 A , ,1 7 “f i l 160% $80 341 375,000 125,000 320.0 $61 i _ 0L5" MW T131 170% $85 $41 382.353 117.647 520.0 $61 , f 171354360 I 180% 690 $41 388.889 111.111 $20.0 $61 . 1,03 V 1 9190 190% 695 34.1 394,737 105,263 620.0 $61 I ' 01114040 ' “$200 200% $100 341 400.000 100.000 961 I DSOQZSZ-Cor—ifl Underiying Stock: Initial Share Price: 1. Excmdes relnvestment 01 upfront proceeds. ' XYZ $100 Floor Level: Cap Level: $20.0 - $100 (100%) $140 (140%) ._ 1/”: ’ _ . . . ‘ 1.2.x: K“: ,. : j , '\ J H... \_ \ur Instanc 5 Where it Is Not Possibie to _ Single Stock isk _ _ Underwriters Lock—up Lack of stock-borrow to implement dealer’s Short saie ”activity ' ' LaCk'of trading liquidity to'SUpporthedging strategy Affiliate issues Max M: hasty/g WW.W-nm m WMW'M” Contractual obligations 0609252-Cor- 1 0 Least Effective Hedge jLLF/L LMcLF‘! _ owed sew-1i mafia? {W e-L - ”Ev. N’ifiha‘) ”i: 905,9 {IF/0 i flWLW} ! yo i 4H “mat; dig/M? LLI‘L ,IV {2 EL )3: ‘Vm’LL it t it} “ Ix""" -_rf\ _. «,t i‘fVVi {La-H” W C 1w}; .:_ . {-3 W {9wa C210 3} Most Effective Hedge 0609252-Cor- 1 0 1;" 3W‘i‘ufi £41}. FLA .3 JDLLQL ndustry and Proxy --v Wm'wmumwwm: we; was. f L - :5 ~53 , 1 M5116 we. H’VL” 5A (ween-“1,15% 69w :asket Hedges . Breed Market Index —- A proxy hedge using a broad market index-(egg S&P 500, NDX 100) Sector—— A proxy hedge with concentrated 1, t«13;'«1219 exposure to an economic sector (e. g._, financial 39W] semces} using an index or a basket of stocks e tndustry - A proxy hedge with concentrated exposure to a specific industry-within a sector (e.g., inyestment banking/brokerage) using an index, single stockor basket of stocks from that industry (e.g., MWD, MER) fiempanV—Spedific —- A direct hedge with conCentrated exposure to the specific company in which the investor has a position WMLW V‘fWM ' 8 (Lb? tnML ‘ Matti) F und Stock ...._ Excha mmwflwmfi - Coni'ributes Stack‘to a . ' '- Limited Partnerslglin ' - Constructs and Manages the Diversified Portfolio for Long~ferm Gro'Wth of ' Capital & Income - _ .. _. a .. - _. fl . -3 WJ 1% (research ' . /“ ”if ‘ M y‘ w z r . fie f‘r‘qW-r) (CR-i :3 . i. - I" - _ _ ‘ _-b LE. WEM P31" f Law/J m “.0”? . W " _ WV 63/9039 . , ‘ _ M «Teak? Significantreduction in exposure to" singie stock risk Possible size limitations _ _ . . I I . - . ' ' OI. e Immediate diversification achieved a se ectnnty of portf '0 manager _ m Illiquidity '- E New tax legislation will require new exchange fund structures a Professionally constructed porthiio a No Rule 144 filings or \rolume limitations - s Excellent estate planning tool l. l 0609252-Cor- 10 Stock Options: —~ Non—qualified stock options — Incentive stock options m Ability of corporate a Non—qualified stock options g” r“ {j i, - insiders and affiliates to (ESOs) generate ordinary ‘3 fl 5 enter into hedging income transactions Exchange traded and over— _ the-counter (OTC) options- generate capital gains; _ gains can potentially be long—term ' requirements . SEC short swing profit I rules —--—__.--...—.———...u.u _.—...——.....—..— Potential mismatCh in character ' a Potential appiicability of IRS . Section 1092 straddle rule 0609252~Cor-50 Potential need for collaterar, other than the ESO, to support certain hedging transactions that involve future obligations on behalf of the client ! l g. l Some individuals have a good portion oftheir "net worth in _' Employee Stock Options. Thereare-two types of Empioyee 10 - \_./‘ . . ' ,- w' Accounting Considerations for Corporations HGdgmg and Mnetlzm CrosshoIdihgs ‘ wmmmwm 123531;.“ x-mrr SAS 133 and its impact on the Income Statement and BalanCe Sheet - Consolidated Earnings _ 0_ WW 4 . - . QVIISP/I I Earnings and assetstonsolidated - {Proportion of earnings and assets ; consolidated ‘ -. 'j sanity Method- Marked to— market, changes - impact earnings Cast Method -- Trading Under 20% I Cost Method In Avaiiable . ' 4; for Saie -- _ i r . Undeg 20% I agingggsln value does not row to . i ..__............. . . I V WIWhen the fourth method is Used - corporations desire cash flow hedge jIé’I “ accounting on derivatives transactions . la nce - heet A MW Wmmfivmws fiflfin w- on June 27 2001, the FASB Board cleared DIG Issue 0 20 which provides that a company can use cash flow hedge accounting for hedging instruments if certain conditions are met Inc-r a WW WMQ‘WW’fl'W ”ROM . : Hedging instrument and . Yes i underlying stock marked-to- ,—-3>] - _ market through 0C1 No Income statement impact I until maturity l i l E Hedging instrument market— to— market through Income I at maturity? . _ . ‘_ . - - Yes statement . _ i I l e ' Is the company committed to i seiiing the underlying shares ' 1 . l 1 Between strike prices, shares c l Are the options purchased, l i marked— t0~market through 0C1 net purchased or zero- I ‘ l premium? ' I I E Outside strike prices, shares Does the hedging instrument ' i ‘ marked—to—market through ‘ No provide the company with |-—I I income statement i ' more downside protection [ = l . than upside partiCIpation? i ' l {special written~optlon test) l I l g I Hedging instrument marked-to- .- l ' market through Income - I No statement - | 12 0609252-Cor- 10 At trade date, company simultaneously purchases a call option and sells a put Option to broker on company’s stock. Company ' . has Significant flexibiiity in determining the maturity date and strike price of put and call warrantsancl realizes no net cash flow on sale of put or purchase of call . e At execution, company selects size, strike price, ' and maturity and receives upfront cash premium from broker n Equity put warrants gives broker the right to sell ' one share of company’s stock to company on a specified date at a gore—determined price At maturity, if stock price is less than put strike, company effectively repurchases shares from broker at the put. strike price. If stock price is between put and call strike, company can repurchase shares in the open market. If stock price is greater than call strike, company effectively repurchases shares from broker at the call strike price i At expiration, if stock price is greater than or equal to strike price, warrant‘expires worthless. If stock price is below put strike price, broker sells one shareof common'stock to company at strike price Advantages . Issuers: tos_,cOn-si'de'r _ Advantages Issueerie-”Consider e Premium is tax-free , E No shares retired if . 3 a E I stock rises nforces share repurchase decision .3‘ ‘3 e Ability to repurchase a fixed number i ‘ of shares within a certain band of future prices is Reduces overall share ' repurchase cost No shares retired until maturity No shares retired until maturity ' Defers cash outlay No upfront cost _' e Captures implicit- option value embedded in company’s share FBDWS program _ . 3 Significant structural flexibility . ' I Retain significant upside appreciation repurchase decision despite significant stock price decreases Defer cash outlay l I | | l i I n Enforces share | l i l i ; 0609252-C0r-10 OSOQZSZ-Cor—lo Accenntmg‘treatment ' : [Impac _ Equity Put Warrant I The sale of puts represents a liability that E Significant — not very popular ' - I is markedeto-market through earnings . I can not marked-to-market, put marked-to— ! cellars I I market Important - much less popular "Corporations and investment banks have found ways to imbed Equity Put Warrants and Collars into Share Repurchases that receive “friendlier”accounting treatment 14 9609252-COP10 Buy $550 million of convertible notes with a coupon of 2.50%, maturing in 2010 Each bond is convertible into approximately 84. 8 shares of Micron {This implies a conversion price of $11. 79 which was 40% higher than Micron' s ciosing pricei'of $8.42 on 1129/2003 If converted, the transaction would add 46.? million shares _ of equity ',_ .c.mm......w—M..w.um._....w {"3 I sale" in we f;- in... Uses $9S million of the “‘“““‘\ proceeds to purchase I _ convertibles financing [JR ‘ Ugwcq Cg“ f _ .1 _ .. w“, . :éljrafiéfi' gait spreads on n Its Interest cost is approximately 5% «CM- . I . "WWW“ / 1m\\\ mag . Each spread costs Micron i I 4 50% X $550mm\:5 +(§550mm" _ j \\ . ' approximateiv $2 5; \\ $455mm_ '- . /i+\$455mm / -\ . If ' ' E: The call-spreads increase the conversion premium from 40% to 116% ‘ Since the call spread never requires that you buy shares, the transaction receives equity accounting treatment E Transaction still has to meet.00-19 ruies Micron raises $455 million in 3.351 Vii/‘53:”? .f‘ii‘iif iii ...
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