chapter 19 convertibles, warrants, and derivatives
TRANSCRIPT
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PPT 19-1
FIGURE 19-1Price movementpattern for a convertible bond
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PPT 19-2TABLE 19-1Pricing pattern for convertiblebonds outstanding, 2002year-end prices
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PPT 19-3
TABLE 19-3Successful convertiblebonds not yet called
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PPT 19-4
TABLE 19-4XYZ Corporation
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Diluted earningsPer share
Adjusted earnings after taxesShares outstanding + All convertible securities5
(19-2)=
PPT 19-4
Reportedearnings
Interest savings
$1,500,000 + $270,0001,000,000 + 400,000
= = =$1,770,0001, 400,000
$1.26
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PPT 19-5
TABLE 19-5Relationships determiningwarrant prices
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PPT 19-6FIGURE 19-2Market price relationships fora warrant
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Review of Formulas PPT 19-7
1. Basic Earnings after taxesearnings = (19-1)per share Shares of Common Stock
2. Diluted Adjusted earnings after taxesearnings = (19-2)per share Shares outstanding
+ All convertibles securities*
*Other types of securities that create common stock, such as warrants and options, would also be included.
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Review of Formulas (continued) PPT 19-7
3. Intrinsic value of a warrant
I = (M — E) X N (19-3)where I = Intrinsic value of a warrant M = Market value of a common stock E = Exercise price of a warrant N = Number of shares each warrant entitles
the holder to purchase
4. Speculative premium of a warrantS = W — I (19-4)
where S = Speculative premium
W = Warrant price I = Intrinsic value
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Chapter 19 - Outline LT 19-1
Convertible Security Convertible Terminology Advantages and Disadvantages of Convertible
Securities Warrant Use of Warrants in Corporate Finance Options
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Convertible Security LT 19-2
Convertible Security: –a hybrid security combining features of debt and common
equity
– a bond or share of preferred stock that can be converted into common stock at the option of the holder
– goes up in value if the common stock price increases
– the holder receives a fixed rate of return before converting
– represents a fixed income security that is potentially convertible into common stock if desired
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Convertible Terminology LT 19-3
Conversion Ratio:– number of shares of common stock into which the security
may be converted
Conversion Price:– par value of the bond / conversion ratio
Conversion Value:– conversion ratio x market price of common stock
Conversion Premium:– difference between the market value and the conversion
value
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Advantages and Disadvantages of Convertible Securities LT 19-4
Advantages to the corporation:– lower interest rate paid than on a straight bond
– may be the only means for a small corporation to gain access to the bond market
– attractive to a corporation that believes its stock is currently undervalued
Disadvantages to the corporation:– average size of a convertible offering is very small
– accounting considerations regarding convertibles (potential dilution of EPS)
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Warrant LT 19-5
Warrant:– an option to buy a stated number of shares of stock at a
specified price over a given time period (a long-term option to buy stock)
–“sweetens” a bond offering (a financial sweetener)
– is usually detachable from the bond issue
– is highly speculative, as its value is dependent on the market movement of the stock
– has a large potential for appreciation if the price of the stock goes up
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Use of Warrants in Corporate Finance LT 19-6
• Enhances a debt issue by allowing for the issuance of debt under difficult circumstances
• May be included as an add-on in a merger or acquisition agreement
• Can be issued in a corporate reorganization or bankruptcy to offer shareholders a chance to recover some of their investment
• Traditionally has been associated with speculative real estate companies, airlines, and conglomerates
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Options LT 19-7
Options give the owner the right, but not the obligation, to buy or sell a security at a set price for a given period of time
An employee stock option is very similar to a warrant Call option
– an option to buy securities Put option
– an option to sell securities