Warrants and Convertibles

Financial Management 2

Warrants and Convertibles• Warrants• Convertibles• Final Comparison of Warrants

and Convertibles

Warrants

Warrant is a long-term option to buy a stated number of shares of common stock at a specified price.

Warrants are Long term Call OptionsInfomatics Corporation, a rapidly growing high-tech company, wanted to sell $50 million of 20-year bonds in 2008, the investment bankers informed management that the bonds would be difficult to sell and that a 10% coupon rate would be required. However, as an alternative, the bankers suggested that investors would be willing to buy the bonds with a coupon rate of only 8% if the company offered 20 warrants with each $1,000 bond, each warrant having a 10-year life and entitling the holder to buy one share of common stock at an exercise price of $22 per share at any time during their 10-year life. Thestock was selling for $20 per share at the time, and the warrants would expire in 2018 if they were not previously exercised.

Warrants

20 10 100080

N I/YR

-829.73

PMT FVPV

OUTPUT

USING FINANCIAL CALCULATOR

Warrants

Detachable Warrant -a warrant that can be detached from a bond and traded independently of the bond.

170/20 = $ 8.50

Use of Warrants in Financing

• Warrants as “sweeteners”• Form of hybrid security

Convertibles

Convertible Security –a security, usually a bond or preferred stock, that can be exchanged at the option of the holder for the common stock of the issuing firm.

Conversion Ratio and Conversion Price

Conversion Price, PC -the effective price paid for common stock obtained by converting a

convertible security.

Conversion Ratio, CR -the number of shares of common stock that are obtained by converting a convertible bond or share of convertible

preferred stock.

Use of Convertibles in Financing

(1) Convertibles, like bonds with warrants, offer a company the chance to sell debt with a low interest rate in exchange for a chance to participate in the company’s success if it does well.

(2) Convertibles provide a way to sell common stock at prices higher than those currently prevailing.

Comparison of Warrants and ConvertiblesWarrants Convertibles

brings in new equity capital switch from debt to equity

contains call provision not callable

shorter maturities longer maturities

interested in selling debt than in selling equity

primarily a “sweetener”

issued by smaller and riskier firms

Issued by larger and less risk firms

higher cost lower cost

END OF LECTURE

EXERCISESIn 2004, Winky’s Cow Paste, Inc., issued $10 million of $ 1,000 par value, 10 percent semi-annual convertible debentures that come due in 2024. The conversion price on these convertibles is $16.75 per share. The common stock was selling for $14- 3/4 per share on a given date shortly after these convertibles were issued. These convertibles have a B-rating, and straight B-debentures were yielding 14 percent on that date. The market price of the convertible was $970 on that date and its security value is $733.60 Determine the following:

a. Conversion ratiob. Conversion valuec. Conversion premium

EXERCISESPetro Tech Inc, currently has some warrants outstanding that allows the holder to purchase, with one warrant, one share of common stock at $18.275 per share. If the common stock was selling at $25 per share and the warrants were selling for $9.50, what would be the

a. Minimum price?b. Warrant premium?

SEATWORKIn 2004, the Andy Fields Corporation of Delaware issued some $1,000 par value, 6 percent convertible debentures that come due in 2024. The conversion price on these convertibles is $40 per share. The price of the common stock now is $27.25 per share. These convertible have BBB rating, and straight BBB debentures are now yielding 9 percent. The market price of convertibles is now $840.25. Determine the following (assume bond interest payments are made annually). Security value is $725.74.

a. Conversion ratiob. Conversion valuec. Conversion premium

SEATWORK

Key answers:

SEATWORK

Key answers: