DISCUSSION OF OPTIMAL DEBT SERVICE: STRAIGHT


 Elfrieda Rogers
 3 years ago
 Views:
Transcription
1 Gunther Friedl * DISCUSSION OF OPTIMAL DEBT SERVICE: STRAIGHT VS. CONVERTIBLE DEBT 1 MOTIVATION AND OBJECTIVE OF THE PAPER Corporate bond default plays a significant role in today s business environment. According to Moody s, a leading provider of credit ratings, corporate bond issuers that it rated as of January 1, 2004, defaulted on a total of US $16 billion in Credit default not only affects the equity investors of a firm, but also the debt holders, who may loose part of their credit. Default can also have dramatic consequences for a firm s future operations. Therefore, the decision of if and when to default is important for both the firm and its stakeholders. There is a substantial body of literature on the determination of optimal default points as a strategic decision by the owners of a firm 1. According to this view, optimal default occurs when the continuation value of the firm, less the discounted value of all future taxadjusted coupon payments, falls below zero. However, some studies on optimal default points are limited, since these studies usually assume a simple capital structure with only equity and straight debt. Christian Koziol extends this literature by relaxing the assumption of a simple capital structure and by allowing for convertible debt. The main objectives of his paper are (i) to determine optimal default and conversion strategies, when debt is convertible; and (ii) to highlight the differences between this strategy and the strategy for straight debt. Since convertible debt plays a significant role in corporate finance decisions, Koziol s approach seems to be both important and of wide interest. To analyze these problems, the author uses a widely accepted timeindependent model with a perpetual bond that pays a continual coupon in the presence of both bankruptcy costs and tax deductibility. My discussion is organized as follows. In section 2, I relate Koziol s paper to previous literature and provide an intuitive explanation for the results. Section 3 discusses an application in the area of real option games. * Gunther Friedl, University Professor, Universität Mainz, Professur für Betriebswirtschaftslehre, insbesondere Controlling, D Mainz, 1 A standard model is Leland (1994). 152 SBR 58 APRIL
2 2 RELATION TO THE LITERATURE AND CONTRIBUTION For traditional financial options, firms usually derive their optimal exercise strategies and the option values without considering the strategic interactions across option holders. Firms base this simplification on the assumption that the option s exercise does not influence the characteristics of the underlying or other options on this underlying. For example, the standard model of the determination of a firm s optimal default strategy uses this assumption (e.g., Leland (1994)). The firm s equity holders have the option to default on debt payments, which can be viewed as an option to sell the firm at an exercise price of zero. In the standard model there are no additional options of other parties, so there is no room for strategic interactions. This assumption can be justified if firms have a simple capital structure with only equity and straight debt. However, if we assume a richer capital structure by including, for instance, convertible debt, this simple view no longer holds. Not only do the equity holders have the option to default, but so do the holders of convertible debt, who have the option to exchange their debt for a fraction of the equity of the firm. In this case, the optimal exercise of the debt holders call option influences the value and the optimal exercise of the equity holder s put option, and vice versa. Now there are strategic interactions across option holders, and a gametheoretic approach must be used to derive the optimal exercise strategies. Two lines of research in the area of strategic option exercise games relate to the paper and are relevant to my discussion. First, there is a substantial body of literature on the strategic exercise of convertible debt and warrants. Examples include Constantinides (1984), who analyzes the equilibrium exercise strategies of a continuum of competitive warrant holders, and Spatt and Sterbenz (1988), who demonstrate that depending on the firm s policy on the use of the exercise proceeds, optimal warrant exercise strategies can be either sequential or simultaneous. Both studies show that strategic interactions across option holders change the results of traditional option pricing theory. While these studies analyze financial options, a second line of literature examines the strategic exercise of real options. Examples include Grenadier (1996), who develops an equilibrium framework for strategic option exercise games. Grenadier uses this framework to analyze the timing of real estate development and provides insights into the forces that shape market behavior. Huisman and Kort (2003) examine the optimal timing of a technology investment of a single firm in a duopoly framework, which they interpret as the exercise of call options on the investment s cash flows. In both cases, the option values and the exercise strategies have properties that strongly differ from the case of a simple option without strategic effects. All these papers analyze the strategic exercise of symmetric call options. Koziol s paper differs from this work in that it considers two different options. Koziol assumes that convertible debt holders can convert their bonds into a fraction γ of total equity. This option is available in perpetuity, which is clearly a simplification of reality. Until conversion, the fi rm continuously pays a coupon C per instant of time. After conversion, SBR 58 APRIL
3 G. FRIEDL convertible debt holders receive γ V, where V represents the asset value of the firm after conversion. Before conversion, Koziol interprets V as the value of an otherwise identical, but purely equity financed, firm after taxes. Obviously, V cannot be observed, so an empirical examination of the model would be difficult, if not impossible. Equity owners hold a put option, which they exercise when the firm stops paying the coupon payment to the debt holders. In this case, the firm is liquidated, equity holders are left with nothing, and debt holders receive the asset value V less bankruptcy costs α V. The asset value V is assumed to follow a geometric Brownian motion, which is a standard assumption in these types of models. As an extension to the standard model, Koziol allows for a nonnegative payout ratio β, which indicates the instantaneous payments to equity holders as a percentage of the asset value V. The basic tradeoffs for equity holders that determines the optimal default strategy are keeping the firm alive, and keeping the claim on instantaneous payments of the payout ratio times the asset value less the taxadjusted coupon payment or declaring default with a payoff of zero. The valuation functions of both equity and convertibledebt holders depend on the exercise strategies of both parties and the asset value. The optimal exercise strategies of equity and debt holders form a Nash equilibrium. Given the optimal conversion strategy of convertible debt holders, equity holders have no incentives to deviate from their default strategy, and vice versa. Koziol can derive these optimal exercise strategies numerically from the smoothpasting conditions for the equity and debt value functions. In the special case in which there is no net payout to equity holders, Koziol obtains a closedform solution for the optimal default strategy. Koziol derives his main results by comparing the modelled firm financed with equity and convertible debt with a fictitious firm financed with only equity and straight debt. Koziol resorts to this fictitious benchmark case, because in practice, convertible securities are frequently decomposed into a straight bond and an option component. The reason for decomposing convertibles is that single components are easier to price. Pricing the straight bond component requires the knowledge of the firm s default strategy. In practice, this default strategy is obtained by considering the fictitious benchmark firm that has only equity and straight debt. This default strategy makes a strong argument for Koziol s benchmark case. Using this firm s strategy for the valuation of the single components instead of the equilibrium strategy of the modelled firm might lead to a different value and different exercise strategies for convertible debt. Koziol s results confirm this deviation. The optimal default for a firm with convertible debt occurs earlier than would a default if the firm were financed with straight debt only. In terms of asset value, the default barrier is higher for the firm with convertible debt than it is for the firm with straight debt. This result has consequences for the optimal conversion strategy. When the firm optimally defaults, the conversion barrier is below the conversion barrier when the firm follows the false strategy. Under the false strategy, the firm acts as if there was no convertible, but only straight, debt. Moreover, the value of convertible debt is higher when firms follow the false straight debt default strategy than when they follow the optimal strategy. 154 SBR 58 APRIL
4 These results are explained by considering the basic tradeoffs for equity holders under the optimal default strategy. On the one hand, if the equity holders keep the firm alive, they keep the claim on instantaneous net payments of the payout ratio times the asset value (uncertain) less the tax adjusted coupon payment (certain). On the other hand, if the equity holders declare default, they get a payoff of zero. Equity holders are worse off if debt holders have a conversion right. The possibility of conversion leads to an additional claim on the firm. Therefore, the claim on the payout ratio times the asset value is worth less than with straight debt only. As described above the basic tradeoff shifts to higher asset values. Hence, optimal default occurs earlier for convertible debt than for straight debt. This result has important implications for creditrating agencies. Firms that use convertible securities in their capital structure should be downgraded relative to otherwise identical firms that are straightdebt financed. Koziol analyzes a number of influencing factors for these results. In particular, he finds that the deviation between the optimal default strategy and the false default strategy is high if the payout rate is low, and if the fraction of total equity obtained by the convertible bond holders upon conversion is high. 3 APPLICATION IN THE AREA OF REAL OPTION GAMES An important application of financial option pricing theory is in the area of real investments. These applications are frequently referred to as real options. Despite concerns on the suitability of option valuation techniques for the valuation of real investments (e.g., Ballwieser (2002)), the literature on real options has grown substantially during the last two decades. Since investment opportunities are often not exclusive to a single firm, strategic interactions across firms must be taken into account. Despite this fact, most of the real options work has been done in the area of exclusive options. Strategic interactions between the investment opportunities of different firms have been mostly neglected. I demonstrate the applicability of Koziol s results in the area of real options. For example, the results explain some licensing behavior characteristics of small firms that acquire the right to use the brand name of a large corporation in a small market segment. Suppose that the value of the brand in this specific market segment follows a geometric Brownian motion, and that existing assets can span the stochastic changes in that value. Assume that the licensee must make continuous payments to the licenser for the right to use the brand name. The difference between the payout from the brand value in this market segment as a fraction of brand value, and the license fee is the licensee s profit. If the brand value decreases, the licensee has the option to stop payments to the licenser by canceling the agreement. In this sense, he possesses a put option. On the other hand the licenser receives the license fees. If the value of his brand name in the specific market increases, he might be tempted to enter this particular market. If he does, the licenser would cancel the agreement with the licensee. In exchange for the forgone future license fees, he receives a fraction of the market value of his brand in this specific market segment. It is reasonable to assume that he only receives a fraction, not the SBR 58 APRIL
5 G. FRIEDL full amount, of the brand value, because he has to cope with difficulties of a new entrant. For example, the licenser s access to distribution channels in this specific market segment might not be as good as the licensee s. Canceling the agreement and entering the new market could be viewed as the exercise of a call option on a fraction of the brand value. Interpreting the equity holder in Koziol s model as the licensee and the convertibledebt holder as the licenser provides some interesting insights into the behavior of firms that enter into licensing agreements. This interpretation can help to value single components of licensing agreements. If the licenser has the option to cancel the licensing agreement and to enter the market, the licensee s market exit occurs earlier than in the case when the licenser must stick to the agreement and cannot enter the market. From the licensee s perspective, a licenser s longterm commitment would be quite valuable. Koziol s model allows for a quantification of this value. Moreover, using the comparative statics results, the model shows the main influencing factors for a high value longterm commitment. For example, the value of this longterm commitment is high if the payment rate for the licensee is relatively low, or if the fraction of the brand value, the licenser receives upon conversion is relatively high. This stylized discussion can serve as a first step in developing new application areas for this model. Of course, the model must be adjusted for different applications. The conditions under which the model can be applied must be carefully analyzed. Most importantly, the spanning condition must hold, i.e., capital markets must be sufficiently complete, so that one could construct a dynamic portfolio of assets, the price of which is perfectly correlated with the asset value V. However, in my view, strategic option games are a way to better understand empirically observable behavior not only in financial, but also in real investment markets. REFERENCES Ballwieser, Wolfgang (2002), Unternehmensbewertung und Optionspreistheorie, Die Betriebswirtschaft 62, Constantinides, George M. (1984), Warrant exercise and bond conversion in competitive markets, Journal of Financial Economics 13, Grenadier, Steven R. (1996), The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets, Journal of Finance 51, Huisman, Kuno J. M. and Peter M. Kort (2003), Strategic investment in technological innovations, European Journal of Operational Research 144, Koziol, Christian (2006), Optimal Debt Service: Straight vs. Convertible Debt, sbr 58, Leland, Hayne E. (1994), Corporate Debt Value, Bond Covenants, and Optimal Capital Structure, Journal of Finance 49, Spatt, Chester S. and Frederic P. Sterbenz (1988), Warrant exercise, dividends, and reinvestment policy, Journal of Finance 43, SBR 58 APRIL
TPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II + III
TPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II III Instructions 1. Only one problem should be treated on each sheet of paper and only one side of the sheet should be used. 2. The solutions folder
More informationCapital Structure. Itay Goldstein. Wharton School, University of Pennsylvania
Capital Structure Itay Goldstein Wharton School, University of Pennsylvania 1 Debt and Equity There are two main types of financing: debt and equity. Consider a twoperiod world with dates 0 and 1. At
More informationCHAPTER 20. Hybrid Financing: Preferred Stock, Warrants, and Convertibles
CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 1 Topics in Chapter Types of hybrid securities Preferred stock Warrants Convertibles Features and risk Cost of capital to issuers
More informationChapter 7. . 1. component of the convertible can be estimated as 1100796.15 = 303.85.
Chapter 7 71 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders
More informationChapter 7. component of the convertible can be estimated as =
Chapter 7 71 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders
More informationDividend Policy. Vinod Kothari
Dividend Policy Vinod Kothari Corporations earn profits they do not distribute all of it. Part of profit is ploughed back or held back as retained earnings. Part of the profit gets distributed to the shareholders.
More informationEC372 Bond and Derivatives Markets Topic #5: Options Markets I: fundamentals
EC372 Bond and Derivatives Markets Topic #5: Options Markets I: fundamentals R. E. Bailey Department of Economics University of Essex Outline Contents 1 Call options and put options 1 2 Payoffs on options
More informationChapter 7: Capital Structure: An Overview of the Financing Decision
Chapter 7: Capital Structure: An Overview of the Financing Decision 1. Income bonds are similar to preferred stock in several ways. Payment of interest on income bonds depends on the availability of sufficient
More informationAthens University of Economics and Business
Athens University of Economics and Business MSc in International Shipping, Finance and Management Corporate Finance George Leledakis An Overview of Corporate Financing Topics Covered Corporate Structure
More informationKey Concepts and Skills Chapter 8 Stock Valuation
Key Concepts and Skills Chapter 8 Stock Valuation Konan Chan Financial Management, Spring 2016 Understand how stock prices depend on future dividends and dividend growth Be able to compute stock prices
More informationChapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)
Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,
More informationExpected default frequency
KM Model Expected default frequency Expected default frequency (EDF) is a forwardlooking measure of actual probability of default. EDF is firm specific. KM model is based on the structural approach to
More informationBond Valuation. What is a bond?
Lecture: III 1 What is a bond? Bond Valuation When a corporation wishes to borrow money from the public on a longterm basis, it usually does so by issuing or selling debt securities called bonds. A bond
More informationHigh Yield Bonds A Primer
High Yield Bonds A Primer With our extensive history in the Canadian credit market dating back to the Income Trust period, our portfolio managers believe that there is considerable merit in including select
More informationFeatures of Common Stock. The Stock Markets. Features of Preferred Stock. Valuation of Securities: Stocks
Valuation of Securities: Stocks Econ 422: Investment, Capital & Finance University of Washington Eric Zivot Fall 27 January 31, 27 Features of Common Stock Voting rights (Cumulative vs. Straight) Proxy
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Hors d Age Cheeseworks has been paying a regular cash dividend
More informationYou just paid $350,000 for a policy that will pay you and your heirs $12,000 a year forever. What rate of return are you earning on this policy?
1 You estimate that you will have $24,500 in student loans by the time you graduate. The interest rate is 6.5%. If you want to have this debt paid in full within five years, how much must you pay each
More informationFUNDING INVESTMENTS FINANCE 238/738, Spring 2008, Prof. Musto Class 6 Introduction to Corporate Bonds
FUNDING INVESTMENTS FINANCE 238/738, Spring 2008, Prof. Musto Class 6 Introduction to Corporate Bonds Today: I. Equity is a call on firm value II. Senior Debt III. Junior Debt IV. Convertible Debt V. Variance
More informationBond Valuation. Capital Budgeting and Corporate Objectives
Bond Valuation Capital Budgeting and Corporate Objectives Professor Ron Kaniel Simon School of Business University of Rochester 1 Bond Valuation An Overview Introduction to bonds and bond markets» What
More informationPutCall Parity. chris bemis
PutCall Parity chris bemis May 22, 2006 Recall that a replicating portfolio of a contingent claim determines the claim s price. This was justified by the no arbitrage principle. Using this idea, we obtain
More informationInvestment and Portfolio Management. Lecture 8 Bond Prices and Yields. Bond Characteristics
Investment and Portfolio Management Ms. Pham Le Thu Nga Lecture 8 Bond Prices and Yields Chapter 14 142 Bond Characteristics Face or par value (normally bullet maturity) Coupon rate (normally fixed) Zero
More informationContingent Convertible Debt and Capital Structure Decisions
Contingent Convertible Debt and Capital Structure Decisions Boris Albul, Dwight Jaffee, Alexei Tchistyi CCBs are gaining attention from both, regulators and market participants Contingent Convertible Bond
More informationThe Valuation of Currency Options
The Valuation of Currency Options Nahum Biger and John Hull Both Nahum Biger and John Hull are Associate Professors of Finance in the Faculty of Administrative Studies, York University, Canada. Introduction
More informationThe cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction
The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal
More informationAFM 271 Practice Problem Set #1 Spring 2005
AFM 271 Practice Problem Set #1 Spring 2005 1. Text problems: Chapter 1 1, 3, 4 Chapter 2 5 Chapter 3 2, 6, 7 Chapter 4 2, 6, 12, 14, 16, 18, 20, 22, 24, 26, 30, 32, 34, 38, 40, 46, 48 Chapter 5 2, 4,
More informationWeek 7  Game Theory and Industrial Organisation
Week 7  Game Theory and Industrial Organisation The Cournot and Bertrand models are the two basic templates for models of oligopoly; industry structures with a small number of firms. There are a number
More information1 Pricing options using the Black Scholes formula
Lecture 9 Pricing options using the Black Scholes formula Exercise. Consider month options with exercise prices of K = 45. The variance of the underlying security is σ 2 = 0.20. The risk free interest
More informationFIN40008 FINANCIAL INSTRUMENTS SPRING 2008
FIN40008 FINANCIAL INSTRUMENTS SPRING 2008 Options These notes consider the way put and call options and the underlying can be combined to create hedges, spreads and combinations. We will consider the
More informationBond Valuation. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Bond Valuation: An Overview
Bond Valuation FINANCE 350 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University 1 Bond Valuation: An Overview Bond Markets What are they? How big? How important? Valuation
More informationFinal Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator
University of Stavanger (UiS) Stavanger Masters Program Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator The number in brackets is the weight for each problem. The weights
More informationOption pricing. Vinod Kothari
Option pricing Vinod Kothari Notation we use this Chapter will be as follows: S o : Price of the share at time 0 S T : Price of the share at time T T : time to maturity of the option r : risk free rate
More informationBlackScholesMerton approach merits and shortcomings
BlackScholesMerton approach merits and shortcomings Emilia Matei 1005056 EC372 Term Paper. Topic 3 1. Introduction The BlackScholes and Merton method of modelling derivatives prices was first introduced
More informationTopics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk
Bond Valuation 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Determinants of Intrinsic Value: The Cost of Debt Net operating profit after taxes Free cash flow
More informationUNC Charlotte Ph.D. in Business Administration Comprehensive Exam Day 2. January 27, 2011
UNC Charlotte Ph.D. in Business Administration Comprehensive Exam Day 2 January 27, 2011 Directions: Today s exam consists of 6 questions. Please answer each question. This exam begins at 11:00am on Thursday,
More informationBonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage
Prof. Alex Shapiro Lecture Notes 12 Bonds and the Term Structure of Interest Rates: Pricing, Yields, and (No) Arbitrage I. Readings and Suggested Practice Problems II. Bonds Prices and Yields (Revisited)
More informationCHAPTER 22: FUTURES MARKETS
CHAPTER 22: FUTURES MARKETS 1. a. The closing price for the spot index was 1329.78. The dollar value of stocks is thus $250 1329.78 = $332,445. The closing futures price for the March contract was 1364.00,
More informationCHAPTER 17 CAPITAL STRUCTURE: LIMITS TO THE USE OF DEBT
CHAPTER 17 B 1 CHAPTER 17 CAPITAL STRUCTURE: LIMITS TO THE USE OF DEBT Answers to Concepts Review and Critical Thinking Questions 1. Direct costs are potential legal and administrative costs. These are
More informationRisk and Return in the Canadian Bond Market
Risk and Return in the Canadian Bond Market Beyond yield and duration. Ronald N. Kahn and Deepak Gulrajani (Reprinted with permission from The Journal of Portfolio Management ) RONALD N. KAHN is Director
More informationBUSM 411: Derivatives and Fixed Income
BUSM 411: Derivatives and Fixed Income 2. Forwards, Options, and Hedging This lecture covers the basic derivatives contracts: forwards (and futures), and call and put options. These basic contracts are
More informationChapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.)
Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing
More informationThe Search for Yield Continues: A Reintroduction to Bank Loans
INSIGHTS The Search for Yield Continues: A Reintroduction to Bank Loans 203.621.1700 2013, Rocaton Investment Advisors, LLC Executive Summary With the Federal Reserve pledging to stick to its zero interestrate
More informationENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure
ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for $40/share. Your analysis of the company
More informationAnswers to Review Questions
Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual
More informationCHAPTER 8 STOCK VALUATION
CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.
More informationChapter 11 Options. Main Issues. Introduction to Options. Use of Options. Properties of Option Prices. Valuation Models of Options.
Chapter 11 Options Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Part C Determination of riskadjusted discount rate. Part D Introduction to derivatives. Forwards
More informationt = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3
MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate
More informationChapter 16 Financial Distress, Managerial Incentives, and Information
Chapter 16 Financial Distress, Managerial Incentives, and Information 161. Gladstone Corporation is about to launch a new product. Depending on the success of the new product, Gladstone may have one of
More informationAmerican Options and Callable Bonds
American Options and Callable Bonds American Options Valuing an American Call on a Coupon Bond Valuing a Callable Bond Concepts and Buzzwords Interest Rate Sensitivity of a Callable Bond exercise policy
More informationGlobal Review of Business and Economic Research GRBER Vol. 8 No. 2 Autumn 2012 : 237245. Jian Zhang *
Global Review of Business and Economic Research GRBER Vol. 8 No. 2 Autumn 2012 : 237245 Jian Zhang * Abstract: This study analyzes the contribution of return on asset (ROA) and financial leverage gain
More information15 Solution 1.4: The dividend growth model says that! DIV1 = $6.00! k = 12.0%! g = 4.0% The expected stock price = P0 = $6 / (12% 4%) = $75.
1 The present value of the exercise price does not change in one hour if the riskfree rate does not change, so the change in call put is the change in the stock price. The change in call put is $4, so
More informationChapter 22 Real Options
Chapter 22 Real Options Multiple Choice Questions 1. The following are the main types of real options: (I) The option to expand if the immediate investment project succeeds (II) The option to wait (and
More informationEquity Value and Per Share Value: A Test
Equity Value and Per Share Value: A Test Assume that you have done an equity valuation of Microsoft. The total value for equity is estimated to be $ 400 billion and there are 5 billion shares outstanding.
More information6. Debt Valuation and the Cost of Capital
6. Debt Valuation and the Cost of Capital Introduction Firms rarely finance capital projects by equity alone. They utilise long and short term funds from a variety of sources at a variety of costs. No
More informationCIS September 2013 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Level 2
CIS September 2013 Exam Diet Examination Paper 2.2: Corporate Finance Equity Valuation and Analysis Fixed Income Valuation and Analysis Level 2 SECTION A: MULTIPLE CHOICE QUESTIONS Corporate Finance (1
More informationTMX TRADING SIMULATOR QUICK GUIDE. Reshaping Canada s Equities Trading Landscape
TMX TRADING SIMULATOR QUICK GUIDE Reshaping Canada s Equities Trading Landscape OCTOBER 2014 Markets Hours All market data in the simulator is delayed by 15 minutes (except in special situations as the
More informationEquity Valuation. Lecture Notes # 8. 3 Choice of the Appropriate Discount Rate 2. 4 Future Cash Flows: the Dividend Discount Model (DDM) 3
Equity Valuation Lecture Notes # 8 Contents About Valuation 2 2 PresentValues 2 3 Choice of the Appropriate Discount Rate 2 4 Future Cash Flows: the Dividend Discount Model (DDM) 3 5 The TwoStage DividendGrowth
More informationOption Pricing Applications in Valuation!
Option Pricing Applications in Valuation! Equity Value in Deeply Troubled Firms Value of Undeveloped Reserves for Natural Resource Firm Value of Patent/License 73 Option Pricing Applications in Equity
More informationPart 9. The Basics of Corporate Finance
Part 9. The Basics of Corporate Finance The essence of business is to raise money from investors to fund projects that will return more money to the investors. To do this, there are three financial questions
More informationAppendix B Weighted Average Cost of Capital
Appendix B Weighted Average Cost of Capital The inclusion of cost of money within cash flow analyses in engineering economics and lifecycle costing is a very important (and in many cases dominate) contributing
More informationCHAPTER 22: FUTURES MARKETS
CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support
More informationCHAPTER 5 HOW TO VALUE STOCKS AND BONDS
CHAPTER 5 HOW TO VALUE STOCKS AND BONDS Answers to Concepts Review and Critical Thinking Questions 1. Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used
More informationInvestment Analysis. Bond Value Bond Yields Bond Pricing Relationships Duration Convexity Bond Options. Bonds part 2. Financial analysis
Bond Value Bond Yields Bond Pricing Relationships Duration Convexity Bond Options Investment Analysis Bonds part 2 Financial analysis  2 Duration Duration = the average maturity of the bond s promised
More informationChapter 15. Learning Objectives Principles Used in This Chapter 1.A Glance at Capital Structure Choices in Practice 2.Capital Structure Theory
Chapter 15 Capital Structure Policy Agenda Learning Objectives Principles Used in This Chapter 1.A Glance at Capital Structure Choices in Practice 2.Capital Structure Theory 3.Why Do Capital Structures
More informationReview for Exam 1. Instructions: Please read carefully
Review for Exam 1 Instructions: Please read carefully The exam will have 21 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation
More informationNew Issuer: China Merchants Land Limited
New Issuer: China Merchants Land Limited China Merchants Land has picked Bank of American Merrill Lynch, DBS, Industrial and Commercial Bank of China as joint global coordinators, joint lead managers
More informationWelcome Unveiling the Results of the First Comprehensive Study on Structured Products in Switzerland
Welcome Unveiling the Results of the First Comprehensive Study on Structured Products in Switzerland Press conference 18 June 2015, SIX ConventionPoint, Zurich Governance Authors of the study Dietmar Maringer,
More informationFULL DISCLOUSURE. IncomeClub, Inc. ("IncomeClub") owns and operates a website at www.incomeclub.co.
FULL DISCLOUSURE June,1 2015 GENERAL DISCLOUSURES IncomeClub, Inc. ("IncomeClub") owns and operates a website at www.incomeclub.co. IncomeClub is registered investment advisor with the Securities and Exchange
More informationChapter 24: The Many Different Kinds of Debt (Convertible Bonds)
Chapter 24: The Many Different Kinds of Debt (Convertible Bonds) Problem Sets (8, 23, 24, 25) Problem 8: (See Ch24, p.644) Maple Aircraft has issued a convertible subordinated debenture due 2020. The conversion
More informationCHAPTER 24 Warrants and Convertibles
CHAPTER 24 Warrants and Convertibles Multiple Choice Questions: I. DEFINITIONS WARRANT b 1. A warrant gives the owner: a. the obligation to sell securities directly to the firm at a fixed price for a specified
More informationFNCE 301, Financial Management H Guy Williams, 2006
REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including
More informationHomework Assignment #1: Answer Key
Econ 497 Economics of the Financial Crisis Professor Ickes Spring 2012 Homework Assignment #1: Answer Key 1. Consider a firm that has future payoff.supposethefirm is unlevered, call the firm and its shares
More informationModeling Exchangeable Bonds WHITE PAPER MONIS CONVERTIBLE BONDS MODELING EXCHANGEABLE BONDS
A Modeling Exchangeable Bonds WHITE PAPER MONIS CONVERTIBLE BONDS MODELING EXCHANGEABLE BONDS Contents 1 Introduction 1 Setting up an exchangeable bond 3 Conclusion 4 Appendix Modeling Exchangeable Bonds
More informationEconomics 173B  Corporate Finance Fall 2016 Prof. Garey Ramey. Study Problems II
Economics 173B  Corporate Finance Fall 2016 Prof. Garey Ramey Study Problems II Problem 4.1. Consider an outstanding bond issue having a coupon rate of 5% and a time to maturity of two years, with interest
More informationHow to Value Employee Stock Options
John Hull and Alan White One of the arguments often used against expensing employee stock options is that calculating their fair value at the time they are granted is very difficult. This article presents
More informationSource of Finance and their Relative Costs F. COST OF CAPITAL
F. COST OF CAPITAL 1. Source of Finance and their Relative Costs 2. Estimating the Cost of Equity 3. Estimating the Cost of Debt and Other Capital Instruments 4. Estimating the Overall Cost of Capital
More informationVALUATION IN DERIVATIVES MARKETS
VALUATION IN DERIVATIVES MARKETS September 2005 Rawle Parris ABN AMRO Property Derivatives What is a Derivative? A contract that specifies the rights and obligations between two parties to receive or deliver
More informationMeasurement Concepts for Banking, Trading, and Investing
Banking,, Banking,, for the MFM Orientation September 1, 2010 Banking,, If you are going to work with bankers, traders, or investment managers, it is important for you to understand the language and concepts
More informationLECTURE 10.1 Default risk in Merton s model
LECTURE 10.1 Default risk in Merton s model Adriana Breccia March 12, 2012 1 1 MERTON S MODEL 1.1 Introduction Credit risk is the risk of suffering a financial loss due to the decline in the creditworthiness
More informationAchievement of MarketFriendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development
Achievement of MarketFriendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development Equity Analysis, Portfolio Management, and Real Estate Practice Quizzes
More informationTHE VALUATION OF A SAVINGS ACCOUNT
THE VALUATION OF A SAVINGS ACCOUNT (With Seven Insights) A savings account is a simple investment that we all understand. We shall use it as a prototype for equity valuation. We shall use it to test ideas
More informationINSURANCE RATING METHODOLOGY
INSURANCE RATING METHODOLOGY The primary function of PACRA is to evaluate the capacity and willingness of an entity / issuer to honor its financial obligations. Our ratings reflect an independent, professional
More informationEcon 330 Exam 1 Name ID Section Number
Econ 330 Exam 1 Name ID Section Number MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If during the past decade the average rate of monetary growth
More informationInvesting on hope? Small Cap and Growth Investing!
Investing on hope? Small Cap and Growth Investing! Aswath Damodaran Aswath Damodaran! 1! Who is a growth investor?! The Conventional definition: An investor who buys high price earnings ratio stocks or
More informationSPDR Wells Fargo Preferred Stock ETF
SPDR Wells Fargo Preferred Stock ETF Summary ProspectusOctober 31, 2015 PSK (NYSE Ticker) Before you invest in the SPDR Wells Fargo Preferred Stock ETF (the Fund ), you may want to review the Fund's prospectus
More informationoptimum capital Is it possible to increase shareholder wealth by changing the capital structure?
78 technical optimum capital RELEVANT TO ACCA QUALIFICATION PAPER F9 Is it possible to increase shareholder wealth by changing the capital structure? The first question to address is what is meant by capital
More informationUniversity of Pennsylvania The Wharton School
University of Pennsylvania The Wharton School FNCE 100 PROBLEM SET #6 Fall Term 2005 A. Craig MacKinlay Capital Structure 1. The XYZ Co. is assessing its current capital structure and its implications
More informationBlack Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869. Words: 3441
Black Scholes Merton Approach To Modelling Financial Derivatives Prices Tomas Sinkariovas 0802869 Words: 3441 1 1. Introduction In this paper I present Black, Scholes (1973) and Merton (1973) (BSM) general
More informationWACC and a Generalized Tax Code
WACC and a Generalized Tax Code Sven Husmann, Lutz Kruschwitz and Andreas Löffler version from 10/06/2001 ISSN 0949 9962 Abstract We extend the WACC approach to a tax system having a firm income tax and
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax
More informationChapter 9 Bonds and Their Valuation ANSWERS TO SELECTED ENDOFCHAPTER QUESTIONS
Chapter 9 Bonds and Their Valuation ANSWERS TO SELECTED ENDOFCHAPTER QUESTIONS 91 a. A bond is a promissory note issued by a business or a governmental unit. Treasury bonds, sometimes referred to as
More informationFIN 413 Corporate Finance. Capital Structure, Taxes, and Bankruptcy
FIN 413 Corporate Finance Capital Structure, Taxes, and Bankruptcy Evgeny Lyandres Fall 2003 1 Relaxing the MM Assumptions E D T Interest payments to bondholders are deductible for tax purposes while
More informationThe Intuition Behind Option Valuation: A Teaching Note
The Intuition Behind Option Valuation: A Teaching Note Thomas Grossman Haskayne School of Business University of Calgary Steve Powell Tuck School of Business Dartmouth College Kent L Womack Tuck School
More informationAbout Hedge Funds. What is a Hedge Fund?
About Hedge Funds What is a Hedge Fund? A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost
More informationBA 351 CORPORATE FINANCE. John R. Graham Adapted from S. Viswanathan LECTURE 5 LEASING FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY
BA 351 CORPORATE FINANCE John R. Graham Adapted from S. Viswanathan LECTURE 5 LEASING FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY 1 Leasing has long been an important alternative to buying an asset. In this
More informationSTUDENT CAN HAVE ONE LETTER SIZE FORMULA SHEET PREPARED BY STUDENT HIM/HERSELF. FINANCIAL CALCULATOR/TI83 OR THEIR EQUIVALENCES ARE ALLOWED.
Test IIIFINN3120090 Fall 2009 (2.5 PTS PER QUESTION. MAX 100 PTS) Type A Name ID PRINT YOUR NAME AND ID ON THE TEST, ANSWER SHEET AND FORMULA SHEET. TURN IN THE TEST, OPSCAN ANSWER SHEET AND FORMULA
More information5Capital Structure II: Stockholder & Bondholder Conflicts
5Capital Structure II: Stockholder & Bondholder Conflicts ModiglianiMiller (MM I) theorem If There are no taxes There are no bankruptcy costs The firm s investment policy is fixed Then The value of the
More informationResearch and Development Expenses: Implications for Profitability Measurement and Valuation. Aswath Damodaran. Stern School of Business
Research and Development Expenses: Implications for Profitability Measurement and Valuation Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 adamodar@stern.nyu.edu Abstract
More informationDCF and WACC calculation: Theory meets practice
www.pwc.com DCF and WACC calculation: Theory meets practice Table of contents Section 1. Fair value and company valuation page 3 Section 2. The DCF model: Basic assumptions and the expected cash flows
More informationUNIVERSITY OF WAH Department of Management Sciences
BBA330: FINANCIAL MANAGEMENT UNIVERSITY OF WAH COURSE DESCRIPTION/OBJECTIVES The module aims at building competence in corporate finance further by extending the coverage in Business Finance module to
More informationBF 6701 : Financial Management Comprehensive Examination Guideline
BF 6701 : Financial Management Comprehensive Examination Guideline 1) There will be 5 essay questions and 5 calculation questions to be completed in 1hour exam. 2) The topics included in those essay and
More information