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HYBRID FINANCING
• Preference Capital
• Valuation of Warrants
Value of the
warrant
Lower limit on
warrant value
Stock price
Exercise price
• Time to expiration
• Stock price
• Exercise price
shares = p = 0.05
• Total number of warrants issued = pN = 0.05 x 20 million = 1
million
• Exercise price =E = Rs 50
• Time to expiration of warrants = 3 months
• Annual standard deviation of stock price changes = σ = 0.40
• Risk – free interest rate = 8 percent
Centre for Financial Management , Bangalore
APPLYING THE BALCK-SCHOLES MODEL
Step 1: Calculate d1 and d2
So 2
ln + r+ t
E 2
d1 =
t
60 0.16
ln + 0.08 + 0.25
50 2
d1 =
0.25
0.1823 + 0.04
= = 1.1115
0.20
d2 = d1 – σ t
= 1.1115 – Centre
0.20 for
= Financial
0.9115Management , Bangalore
Step 2: Find N(d1) and N (d2). N (d1) and N (d2) represent the probabilities that a
random variable that has a standardised normal distribution will assume
values less than d1 and d2
N (d1) = N (1.1115) = 0.8668
N (d2) = N (0.9115) = 0.8190
Step 3: Estimate the present value of the exercise price, using the continuous
discounting principle
E Rs.50 Rs.50
= = = Rs.49.01
ert e 0.08 x 0.25 1.0202
Value of
Convertible
debentures
Firm value
(c) Value of convertible debentures
MOTIVES FOR ISSUING WARRANTS AND
CONVERTIBLE DEBENTURES
Conventional Explanations
• Cheaper debt
• Equity at a premium
Type Example
• Hybrids to manage • Oil-indexed bond
commodity risk
• Hybrids to manage forex • Dual currency bond
risk
• Hybrids to manage interest • Inverse floating rate note
rate risk
• Hybrids to reduce conflicts • Floating rate, rating
between bondholders and sensitive
stockholders note
Centre for Financial Management , Bangalore
EVALUATION OF HYBRIDS
Two primary economic reasons for the popularity of
hybrids
• Make market more complete
• Provide a tax or regulatory advantage