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Ch 21

Ch 21

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Chapter - 21

Convertible Debentures and Warrants

Why Issue Convertible Debenture
 Sweetening debentures to make them

attractive.  Selling ordinary shares in future at a higher price.  Avoiding immediate dilution of earnings.  Using low cost capital initially.

Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd.

2

Valuation of Convertible Debenture
 A convertible debentures market value depends

on both investment and conversion value. Market value is higher than both the investment and conversion value. The difference is the conversion premium. The premium results because the convertible debenture offers fixed income at a low risk of price decline while assuming the chances of capital gains when the share prices increases.

Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd.

3

Warrants–Definition
A warrant entitles the purchaser to buy a fixed number of ordinary shares at a particular price during a specified time period. It is similar to an American call option.

Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd.

4

Warrants–Features
 Exercise Price  Exercise Ratio  Expiration Date  Detachability  Right

Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd.

5

Warrants–Valuation
 Theoretical Value = (Share Price – Exercise Price)* Exercise Ratio  If the share price is less than the exercise price

the warrants theoretical value is zero.  The difference between the warrants’ market value and its theoretical value is called the premium.  Black–Scholes Model (after required adjustment) can be used to value warrants.
Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd. 6

Why Issue Warrants
   

Sweetening Debt Deferred Equity Financing Cash Inflow in Future Other Advantages
1. 2. 3.

Warrants keep the share prices high. Investor enabled to have access to shares without investing now. Enables promoters to increase their holdings.

Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd.

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Zero-Interest Debentures (ZID)
 ZID or zero coupon bonds or deep discount

bonds do not carry an explicit rate of interest. The difference between the face value of the bonds and its purchase price is the return to the investors.  Mahindra & Mahindra was the first company in India to issue convertible zero interest bonds in January 1990.  The purely zero-interest debenture was issued by Best and Crompton Engineering Company in December 1990.
Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd. 8

Secured Premium Notes
 Secured premium note is a secured

debenture redeemable at a premium. It is a medium to long term debenture. TISCO issued SPNs with warrants attached in India for the first time to raise Rs 346.5 Cr.

Financial Management, Ninth Edition © I M Pandey Vikas Publishing House Pvt. Ltd.

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