Unit 2 S1 Research Paper

11245 Words45 Pages
Supplementary Notes: Hybrid Securities by Kyung Hwan Shim University of New South Wales Australian School of Business School of Banking & Finance for FINS 3625 S1 2011 May 24, 2011 ∗ These notes are preliminary and under development. They are made available for FINS 3625 S1 2011 students only and may not be distributed or used without the author’s written consent. ∗ 1 Contents 1 Introduction 2 Preferred Stocks 2.1 2.2 Advantages of Issuing Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . Weak Points of Issuing Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . 3 5 6 7 7 8 10 10 11 11 11 13 16 16 17 18 20 20 21 22 28 32 3 Warrants 3.1 3.2 3.3 3.4 3.5 3.6 Warrant’s Payoff Structure and its Value…show more content…
Figure 1 shows the profits from the exercise of a warrant when n = 1 and K = $5 for different values of St . As shown in the figure, if St is lower than K, it is not advantageous for the holder to exercise the warrant and the payoff is zero. However, if St is greater than K, the payoff is the difference St − K, and it is greater the greater St is. Because a warrant’s payoff is greater the larger the value of the underlying stock, a warrant holder can choose not to exercise the warrant even if the payoff is positive because he may expect that St will rise even further in the future. Because most warrants can be exercised any time before their expiration date, the profit the holder would receive if he were to exercise a warrant immediately is called the warrant’s intrinsic value. Figure 1 shows the intrinsic value of a warrant as a function of the underlying stock’s price…show more content…
Each bond carries 20 warrants with a strike price of $6 and expire in 10 years. Each warrant after exercised grants the holder one stock. The market yield on bonds of compatible investment grade is 10% and likely to remain constant. What is the price of each warrant at time of issue? What is ABCs expected share price post exercise of warrants? What is the yield on ABCs bonds with warrants? Solution: The price of ABC’s straight bond at time of issuance is B= 1, 000 + $50 $50 $50 + ... + + 2 1 + 10% (1 + 10%) (1 + 10%)20 1 − (1 + 10%)−20 $1, 000 = $50 × + 10% (1 + 10%)20 = $574.32 The value of a warrant at time of issuance is W = $1, 000 − $574.32 = $21.28

More about Unit 2 S1 Research Paper

Open Document