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Ian H. Giddy/NYU Structured Finance-1
Prof. Ian GiddyNew York University
Structured Finance:Equity
Copyright ©2002 Ian H. Giddy Structured Finance 2
Structured Finance
l Asset-backedsecuritization
l Corporate financialrestructuring
l Structured financingtechniques
Ian H. Giddy/NYU Structured Finance-2
Copyright ©2002 Ian H. Giddy Structured Finance 3
When Debt and Equity are Not Enough
Valueof future
cash flows
Valueof future
cash flows
Contractual int. & principalNo upside
Senior claimsControl via restrictions
Contractual int. & principalNo upside
Senior claimsControl via restrictions
Assets Liabilities
Debt
Residual paymentsUpside and downside
Residual claimsVoting control rights
Residual paymentsUpside and downside
Residual claimsVoting control rights
Equity
Copyright ©2002 Ian H. Giddy Structured Finance 4
When Debt and Equity are Not Enough
Valueof future
cash flows
Valueof future
cash flows
Contractual int. & principalNo upside
Senior claimsControl via restrictions
Contractual int. & principalNo upside
Senior claimsControl via restrictions
Assets Liabilities
Debt
Residual paymentsUpside and downside
Residual claimsVoting control rights
Residual paymentsUpside and downside
Residual claimsVoting control rights
Equity
Alternatives
n Collateralizedn Asset-securitizedn Project financing
n Preferredn Warrantsn Convertible
Ian H. Giddy/NYU Structured Finance-3
Copyright ©2002 Ian H. Giddy Structured Finance 5
Case Studies
l Ban Pu Convertible Bond;l Keppel T&T Convertible;l Singapore Warrant Bonds;l Lyons;l Endesa
Copyright ©2002 Ian H. Giddy Structured Finance 6
A Day in the Lifeof the Eurobond Market
l Examine the dealsuWhich were structured financing?uWhy were each done in that particular
form?uWhat determines the pricing?
l Can you break the hybrids into theircomponent parts?
Ian H. Giddy/NYU Structured Finance-4
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A Day in the Life...
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Equity-Linked Bonds
l Bonds with warrantsl Convertible Bondsl Index-linked Bonds
These are all example of hybrid bondsand should be priced by decomposition
Ian H. Giddy/NYU Structured Finance-5
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Convertibles
ConversionValue
StraightBond Value
Market ValueMarket Premium
ValueofConvertibleBond
($) 0
Price Per Share of Common Stock
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Warrants
TheoreticalValue
Market ValueMarket Premium
Value
of
Warrant
($)
0Price Per Share of Common Stock ($)
Ian H. Giddy/NYU Structured Finance-6
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Index-Linked
PRINCIPALREPAYMENT
Copyright ©2002 Ian H. Giddy Structured Finance 12
Stock-Purchase Warrants
l Warrants are usually detachable and tradeon the securities exchanges
l Warrants are often added to a large debtissue as “sweeteners” to enhance themarketability of the issue
l Exercise pricel Warrants usually have a limited life of about
10 years or lessl Warrants differ from rights and convertibles
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The Implied Price of an AttachedWarrant
l To determine the implied price of an attachedwarrant, the implied price of all warrants attachedto a bond must be determined
l Implied price of all warrants = price of bond withwarrants attached - the straight bond value (ofsimilar-risk bonds)
l The impled price of a single warrant is the impliedprice of all warrants divided by the number ofwarrants attached to each bond
Copyright ©2002 Ian H. Giddy Structured Finance 14
The Value of Warrants
l A warrant has a “theoretical value” at any point intime prior to its expiration date
l The theoretical value can be calculated as:TVW = (Po - E) x NWHERE:
TVW = Theoretical value of a warrantPo = Current market price of one share of
common stockE = Exercise price of the warrantN = Number of shares of common stock
obtainable with one warrant
Ian H. Giddy/NYU Structured Finance-8
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Sony Warrants
l Sony Electronics has outstanding warrants exercisable atYen400/share that entitle holders to purchase threeshares of common stock per warrant. If Sony’s commonstock is currently selling for Y45/share, the TVW =
l TVW = (Y45 - Y40) x 3 = Y15
l The market value of a warrant is generally greater than itstheoretical value; the difference, known as the warrantpremium is due to investor expectations and opportunitiesfor further gain before expiration.
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Values and Warrant Premium
TheoreticalValue
Market ValueMarket Premium
Value
of
Warrant
($)
0Price Per Share of Common Stock ($)
1994, HarperCollins PublishersCopyright
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Copyright ©2002 Ian H. Giddy Structured Finance 17
Option Pricing
94.5
Option Price= Intrinsic value + Time value
Option Price
UnderlyingPrice
94.75
Time value depends onn Timen Volatilityn Distance from the strike price
Time value depends onn Timen Volatilityn Distance from the strike price
Copyright ©2002 Ian H. Giddy Structured Finance 18
Option Pricing Model
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
93 93 94 94 95 95 96 96FUTURES PRICE
CA
LL O
PTI
ON
PR
ICE
ENTER THESE DATA:=================
-> FUTURES PRICE 94.75-> STRIKE PRICE 94.5-> TIME IN DAYS 300-> INTEREST RATE 7-> STD DEVIATION 15
CALL PRICE IS......... 0.40PUT PRICE IS....... 0.17
Ian H. Giddy/NYU Structured Finance-10
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Value of Call Option
INTRINSIC VALUE TIME VALUE
EXPECTED VALUE OF PROFITGIVEN EXERCISE
STRIKE
FUTURES
PRICE
SHADED AREA:
Probability distribution ofthe log of the futuresprice on the expirationdate for values abovethe strike.
Copyright ©2002 Ian H. Giddy Structured Finance 20
Black-Scholes Option Valuation
Co = SoN(d1) - Xe-rTN(d2)d1 = [ln(So/X) + (r + σ2/2)T] / (σ T1/2)d2 = d1 - (σ T1/2)whereCo = Current call option value.So = Current stock priceN(d) = probability that a random draw from a
normal dist. will be less than d.
Ian H. Giddy/NYU Structured Finance-11
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Convertible Bonds
l Bond may be converted into stockl The Conversion Ratio is the number of
shares of common stock that can bereceived in exchange for eachconvertible security
l The Conversion Price is the per sharecommon stock price at which theexchange effectively takes place
Copyright ©2002 Ian H. Giddy Structured Finance 22
Convertibles
u The Conversion Period is a limited timewithin which a security may be exchangedfor common stock
u The Conversion Value is the market value ofthe security based upon the conversionratio times the current market price of thefirm's common stock
u Earnings effects:w Firms must report Primary EPS, treating all contingent securities
that derive their value from their conversion privileges orcommon stock characteristics as common stock
w Firms must report Fully Diluted EPS treating all contingentsecurities as common stock
Ian H. Giddy/NYU Structured Finance-12
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Example: Hyundai Euroconvertible
l If Hyundai issues a Eurobond with a $1,000 parvalue that is convertible at $40 per share ofcommon stock, the conversion ratio =
$1,000 = 25 $40l If Hyundai had stated the conversion ratio at 20,
the conversion price =$1,000 = $50 20
Copyright ©2002 Ian H. Giddy Structured Finance 24
Financing With Convertibles
l Motives for using convertibles include:u It is a deferred sale of common stock that decreases
the dilution of both ownership and earningsuThey can be used as a “sweetener” for financinguThey can be sold at a lower interest rate than
nonconvertiblesuThey have far fewer restrictive covenants than
nonconvertiblesu It provides a temporarily cheap source of funds
(assuming bonds) for financing projectsl Most convertibles have a call feature that enables the
issuer to force conversion when the price of the commonstock rises above the conversion price
Ian H. Giddy/NYU Structured Finance-13
Copyright ©2002 Ian H. Giddy Structured Finance 25
Determining the Value of a ConvertibleBond
There are three values associated with aconvertible bond:uStraight Bond Value is the price at which the bond
would sell in the market without the conversion featureuThe Conversion Value is the product of the current
market price of stock times the conversion ratio of thebond
uThe Market Value is the straight or conversion valueplus a market premium based upon future (expected)stock price movements that will enhance the value ofthe conversion feature
Copyright ©2002 Ian H. Giddy Structured Finance 26
Siam Cement
l Siam Cement sold a $1,000 par value, 20-year convertible bond witha 12% coupon. A straight bond would have been sold with a 14%coupon. The conversion ratio is 20
l Straight Bond Value$120 x (PVIFA14%,20) + $1,000 x (PVIF14%,20) =$120 x (6.623) + $1,000 x (.073) = $867.76
uConversion Value at various market prices of stockStock Price Conversion Value
$30 $ 600 40 800 50 (Conversion Price) 1,000 (Par Value) 60 1,200
70 1,400 80 1,600l The straight bond value is the minimum price at which the convertible
bond would be traded
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Values and Market Premium
ConversionValue
StraightBond Value
Market ValueMarket Premium
Value
of
Convertible
Bond
($) 0
Price Per Share of Common Stock
Copyright ©2002 Ian H. Giddy Structured Finance 28
Breaking Down a Convertible: Kodak
l At the end of 2001, Kodak (EK) had a 5.25%convertible bond, coming due in 2009, tradingat $1300. The face value was $1000. It alsohad straight bonds, with the same maturity,trading in December 2001 at a yield of 8.4%.uWhat’s the straight bond component worth?uWhat’s the convertible option worth?uAssume the conversion ratio is 24, and Kodak
stock is priced at $51. How would you determinewhether the investor is overpaying?
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Breaking Down a Convertible
Coupon rate on Convertible Bond = 8.25%Market Interest Rate on Straight Bond of same Risk = 8.40%Price of Convertible Bond = 1400Maturity of Convertible Bond = 8
Value of Straight Bond Portion = 991.51$ Value of Conversion Option = 408.49$
Copyright ©2002 Ian H. Giddy Structured Finance 30
Case Study:Banpu Convertible
nHow did this work?nWhy did Banpu use this technique?nWhy did investors buy it?
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Copyright ©2002 Ian H. Giddy Structured Finance 31
Banpu Convertible
Huh?
Copyright ©2002 Ian H. Giddy Structured Finance 32
Thai Time
n 1994 n 1997 n 1999 n 2004
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Motivations for Issuing Hybrid Bonds
l Company has a viewl There are constraints on what the
company can issuel The company can arbitrage to save
moneyl Always ask: given my goal, is there an
alternative way of achieving the sameeffect (e.g., using derivatives?)
Copyright ©2002 Ian H. Giddy Structured Finance 34
Why Use a Hybrid?
Motivations for Hybrids
Linked tobusiness risk
Linked tomarket risk
Cannot hedgewith derivatives
Driven by investorneeds
Companyhedges
Companydoes not
hedge
Debt or
equity areNot good enough
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Copyright ©2002 Ian H. Giddy Structured Finance 39
Contact Info
Ian H. GiddyNYU Stern School of BusinessTel 212-998-0426; Fax [email protected]://giddy.org