CFA Institute

C D WarrantsAuthor(s): Allen FordSource: Financial Analysts Journal, Vol. 26, No. 4 (Jul. - Aug., 1970), p. 128Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4470714 .

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pose there are two companies, A and B, with identical distributions of em- ployees by age, sex, service and salary. If pension costs for both A and B were computed by the same actuary, the dollar amount of cost would be identi- cal. But not all actuaries are alike. Some are more conservative than others.

Company A hires actuary a, who as- sumes that their pension fund will earn 6,%o. Company B hires actuary b, who assumes that their pension fund will earn 4%/4. Otherwise, all of the assumptions of the two actuaries are identical. The annual cost of plan A is $100,000, while the annual cost of plan B is $150,000. The fund manager for company A produces a yield of 6%, exactly what the actuary prescribed. The fund manager for company B produces a yield of 4%ho, again, exactly what the actuary prescribed. In each

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case the fund manager exactly met his objective. Actual pension costs for company B are 150%c of those of com- pany A, but according to the Gumperz- Page theory the actuary rather than the fund manager was responsible for the added cost. If their theory were valid, no employer in his right mind would hire a conservative actuary.

Following the more generally ac- cepted theory of the respective roles of the actuary and the fund manager, the managers of the -funds for company A and company B might produce an over-all yield in each fund of, say, 7%c. As a result, the actual cost of each of the plans would be somewhat less than $100,000, even though the conservative actuary, b, estimated initially that the cost of plan B would be $150,000. This would confirm what has been generally accepted for many years - that the actual cost of a pension plan depends upon actual experience, not on the calculations made by the actuary.

B. RUSSELL THOMAS Fellow of the Society of Actuaries The Wyatt Company Chicago, Illinois

C D WARRANTS The subsequent remarks relate to

the article, "C D Warrants" by Ken- neth Yeasting which was published in the March-April 1970 issue of Finan- cial Analysts Journal.

Given Yeasting's assumption of a free market for the debt, I cannot find any advantage justifying a policy de- signed to induce a rational warrant holder to tender debt when exercising C D warrants. W hen the warrant holder tenders bonds rather than cash, the company receives less considera- tion for their equity than would be the case if cash were given. If the objec- tive is to retire debt, it is still not essential for warrant holders to tender debt since the firm could obviously use the cash to meet that objective.

Yeasting maintains that CD war- rants differ from straight warrants since "in the case of C D warrants, management has no choice on whether the debt will be converted into equity if the debt is tendered upon the exer- cise of the CD warrant." However, it does not appeat that such a distinc- tion really exists since management has just as much flexibility when deal- ing with proceeds from execution of a straight warrant as in the case of a C D warrant (i.e., tendered bonds could be resold to obtain cash; tendered cash could be used to retire bonds, etc.).

It is true that management will have less consideration to work with when C D warrants are tendered with debt.

In summary, it appears that the role of C D warrants relative to straight warrants is overplayed in this article. The only significant differences be- tween the two would be that CD war- rants have both a fixed and fluctuating exercise price as long as debt is out- standing and CD warrants may pos- sibly command a higher price when issued t'han straight warrants.

ALLEN FORD

College of Economics and Business Washington State University

Index to Advertisers

Allegheny Ludlum Industries ..... .... 24-25 Anthony Kane ....................... 103 Baldwin Piano & Organ Co ...... ...... 123 Beneficial Corporation ......... ....... 126 Booth Newspapers, Inc . ............... 103 Burnham & Company ......... ........ 123 Central Soya, Inc . ............... 3rd Cover Chemical Bank ...................... 37 Columbia Gas ....................... 113 Dayton Power & Light ......... ....... 124 Dynalectron ......................... 64 L. M. Ericsson Telephone Company ..... 38 ESB, Inc .......................... 17 Flintkote .......................... 18 General Telephone & Electronics .. . 2nd Cover Goodyear Tire & Rubber ....... ....... 128 Greenman Corporate Consultants ........ 48 Greyhound Lines, Inc . ............ 4th Cover Gulf States Utilities ......... ........ 120 I.T.T. ................ ....... 63 Middle South Services ......... ....... 122 Middle South Utilities ......... ....... 126 National Distillers ............ ....... 128 North American Royalties ....... ...... 73 Ohio Edison Company ......... ....... 49 Panhdndle Eastern ............ ....... 126 Philadelphia Electric Company ..... .... 119 Public Service Electric & Gas ...... 55, 126 St. Joe Minerals Corporation ...... ..... 1 Swiss Caribbean Development & Finance . 120 Toledo Edison ....................... 127 Transamerica Corporation ....... ..... 26-27 U. S. Steel ......................... 8-9 University Computing ....... .......... 23 Utah Power & Light ....... ......... 47 Wisconsin Electric Power ...... ........ 61

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128 FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1970

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