EquityInstrumentsAndPortfolioConstruction

Click to edit Master title style,Click to edit Master text styles,Second Level,Third Level,Fourth Level,Fifth Level,Copyright 1998 Ian H. Giddy,Equity instruments,56,Equity Instruments,And,Portfolio Construction,Prof. Ian Giddy,New York University,New York University/ING Barings,Equity Instruments,Equity in financing,Rights,Warrants,Convertibles,Equity,What it is,How its issued,Debt vs. Equity,Value,of future,cash flows,Claims on,the cash flows,Assets,Liabilities,Debt vs Equity,Value,of future,cash flows,Contractual int. & principal,No upside,Senior claims,Control via restrictions,Assets,Liabilities,Debt,Residual payments,Upside and downside,Residual claims,Voting control rights,Equity,Methods of Issuing New Securities,MethodTypeDefinition,Public Offerings,Negotiated Cash OfferFirm CommitmentCompany negotiates agreement Cash Offerwith investment banker to underwrite and distribute the new stocks.,Best Efforts Cash OfferInvestment bankers sell as much as possible at the agreed-upon price. No guarantee as to how much cash will be raised.,Privileged SubscriptionDirect Rights OfferCompany offers new stock directly to existing stockholders.,Standby Rights OfferSimilar to direct rights offer, but net proceeds are guaranteed by the underwriters.,Methods of Issuing New Securities (concluded),MethodTypeDefinition,Public Offerings,Nontraditional Cash OfferShelf Cash OfferQualifying companies can authorize all shares they expect to sell over a two year period and sell them when needed.,Competitive Firm Company can elect to award Cash offerunderwriting contract through a public auction instead of negotiation.,Private Offerings,PrivateDirect PlacementSecurities are sold directly to purchaser, who, at least until very recently, generally could not resell securities for at least two years.,Equity Issuance: A Red Herring,Subject to Completion, Dated December 19, 1989,25,000,000 Shares,The Readers Digest Association, Inc.,Class A Nonvoting Common Stock(par value $0.01 per share),Of the 25,000,000 shares of Class A Nonvoting Common Stock offered, 21,000,000 are being offered hereby in the United Sates and 4,000,000 are being offered in a concurrent international offering outside the United States. The initial public offering price and the aggregate underwriting discount per share will be identical for both Offerings. The closing of the U.S. Offering is a condition to the closing of the International Offering, but the closing of the International Offering is not a condition to the closing of the U.S. Offering. See “Underwriting”.,All of the shares of Class A Nonvoting Common Stock offered are being sold by the Selling Stockholders. See “Selling Stockholders”. The Company will not receive any of the proceeds from the sale of shares by the Selling Stockholders. (continued),A Red Herring (continued),Prior to the Offerings, there has been no public market for shares of Class A Nonvoting Common Stock. It is currently anticipated that the initial public offering price will be in the range of $18 to $22 per share. For the factors to be considered in determining the public offering price, see “Underwriting”.,Application will be made to list the shares of Class A Nonvoting Common Stock on the New York Stock Exchange.,These securities have not been approved or disapproved by the securities and exchange commission nor has the commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.,(continued),A Red Herring (continued),Initial PublicUnderwritingProceeds to Selling,Offering Price,Discount (1),Stockholders (2),Per Share. $ $ $Total (3). $ $ $,(1)The Company and the Selling Stockholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933.,(2)Before deducting expenses, estimated to be $ , of which $ will be payable by the Company and $ will be payable by the Selling Stockholders.,(3)The Selling Stockholders have granted the U.S. Underwriters an option for 30 days to purchase up to an additional 3,150,000 shares at the initial public offering price per share, less the underwriting discount, solely to cover over-allotments. Additionally, the Selling Stockholders have granted an over-allotment option with respect to an additional 600,000 shares as part of the International Offering. If such options are exercised in full, the total initial public offering price, underwriting discount and proceeds to Selling Stockholders will be $ and $, respectively. See “Underwriting”. (continued),A Red Herring (concluded),The shares offered hereby are offered severally by the U.S. Underwriters, as specified herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that the certificates for the Shares will be ready for delivery at the offices of Goldman, Sachs & Co., New York, New York on or about , 1990.,Goldman, Sachs & Co. Lazard Freres & Co.,The date of this Prospectus is ,1990.,Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State.,Tombstone Ad of an Equity Offering,58,750 Shares,Consolidated Rail Corporation,Common Stock,(par value $1.00 per share),_,Price $28 Per Share,_,The shares are being sold by the United States Government pursuant to the Conrail Privatization,Act. The Company will not receive any proceeds from the sale of the shares.,Upon request a copy of the Prospectus describing these securities and the business of the Company may be obtained within any State from any Underwriter who may legally distribute it within such State. The securities are offered only by means of the Prospectus, and this announcement is neither an offer to sell nor a solicitation of any offer to buy.,52,000,000 Shares,The portion of the offering is being offered in the United States and Canada by the undersigned.,(continued),Tombstone Ad (continued),Goldman, Sachs & Co.,The First Boston Corporation,Merrill Lynch Capital Markets,Morgan Stanley & Co.,Salomon Brothers, Inc.,Shearson Lehman Brothers, Inc.,Alex Brown & Sons Dillon, Read &Co. Inc. Donaldson, Lufkin & Jenrette Drexel Burnham Lambert Hambrecht & Quist E.F. Hutton & Co. Inc.,Incorporated Securities Corporation IncorporatedIncorporated,Kidder, Peabody & Co. Lazard Freres & Co. Montgomery Securities Prudential-Bache Capital Funding Rbertson, Colman & Stephens,Incorporated,L.F. Rothschild, Unterberg, Towbin, Inc.Smith Barney, Harris Upham & Co. Wertheim Schroeder & Co. Dean Witter Reynolds Inc.,Incorporated Incorporated,William Blair & Company J.C. Bradford & Co. Dain Bosworth A.G. Edwards & Sons, Inc. McDonald & Company Oppenheimer & Co., Inc.,Incorporated Incorporated Incorporated,Piper, Jaffray & Hopwood Prescott, Ball & Turben, Inc. Thomson McKinnon Securities Inc. Wheat, First Securities, Inc.,Incorporated,Advest, Inc. American Securities Corporation Arnhold and S.Bleichroeder, Inc. Robert W. Baird & Co. Bateman, Eichler, Hill Richards,Incorporated Incorporated,Sangfroid C. Bernstein & Co Inc Blunt Ellis & Loewl Boettcher & Co Inc Burns Fry and Timmins Inc Butcher & Singer Inc Cowen & Company,Incorporated,Dominion Securities Corporation Eberstadt Fleming Inc Eppler, Guerin & Turner Inc First of Michigan Corp. First Southwest Company,Furman Selz Mager Dietz & Birney Gruntal & Co Inc Howard, Well, Laboulsse, Friedrichs Interstate Securities Corporation,Incorporated Incorporated,Janney Montgomery Scott Inc Johnson, Lane Smith & Co Inc. Johnston, Lemon & Co. Josephthal & Co. Ladenburg, Thalmann & Co Inc.,Incorporated Incorporated,Cyrus J. Lawrence Legg Mason Wood Walker Morgan Keegan & company Inc Moseley Securities Corporation Needham & Company Inc.,IncorporatedIncorporated,Neuberger & Berman The Ohio Company Rauscher Pierce Refanes Inc The Robinson-Humphrey Co Inc Rothschild Inc Stephens Inc,Stifel, Nicolaus & Company Sutro & Co. Tucker, Anthony & R. L. Day, Inc. Underwood, Neuhaus & Co. Wood Grudy Corp.,Incorporated Incorporated Incorporated,(continued),This special bracket of minority-owned and controlled firms assisted the Co-Lead,Managers in the United States Offering pursuant to the Conrail Privatization Act:,AIBC Investment Services Corporation Daniels & Bell, Inc. Dolsey Securities, Inc.,WR Lazard SecuritiesPryor, Govan Counts & Co. Inc. Muriel Siebbert & Co., Inc.,6,750,000 Shares,This portion of the offering is being offered outside the United States and Canada by the undersigned,Goldman Sachs International Corp.,First Boston International Limited,Merrill Lynch Capital Markets,Morgan Stanley International,Salomon Brothers International Limited,Shearson Lehman Brothers International,Algemene Bank Nederland N.V. Banque Bruxelles Lambert S.A. Banque Nationale de Paris Cazenove & Co. The Nikko Securities Co. (Europe) Ltd.,Nomura International N.M. Rothschild & Sons J. Henry Schroder Wagg & Co. Societe Generale S. G. Warburg Securities,Limited Limited Limited,ABC International Ltd. Banque Paribas Capital Markets Limited Calsse Nationale de Credit Agricole Compagnie de Banque et dinvestissements, CBI,Credit Lyonnais Daiwa Europe IMI Capital Markets (UK) Ltd. Joh. Berenberg, Gossier & Co. Leu Securities Limited,Limited,Morgan Greenfell & Co. Peterbroeck, van Campenhout & Cie SCS Swiss Volksbank Vereins-und Westbank,Aldengrundschaft,J. Vontobel & Co. Ltd. M. M. Warburg-Brinckmann, Wirtz & Co. Westdeutsche Landesbank Yamaichi International (Europe),Limited,March 27, 1967,A Tombstone Ad (concluded),Rights Offerings,Rights offering,Share rights,Offering terms,Subscription price,Number of rights to purchase a share,Value of a right,Ex Rights Stock Prices,Rights On,Ex Rights,Announcement,date,date,date,Ex-rights,Record,September 30,October 13,October 15,Rights-on price,$20.00,Ex-rights price,$16.67,$3.33 =Value of a right,The Value of a Right,The value of a right equals the difference in the price of the issuers outstanding shares before and after the rights offering, and is determined by three factors:,- the total amount of money to be raised,- the subscription price of the new shares, and,- the number of existing shares.,The number of new shares to be issued equals,(Funds to be raised)/Subscription price,The Value of a Right (concluded),The number of rights needed to buy one share equals,(Number of old shares)/(Number of new shares),After the offering, the new value of the firm is,Pre-offering firm value + funds raised,and the new share price must be,(New firm value)/(Total number of shares outstanding),.,The value of the right must equal,Old share price - new share price,.,Rights Offering: Example,Rio Algom Mining Co. is proposing a rights offering. Presently there are 250,000 shares outstanding at $50 each. There will be 50,000 new shares offered at $40 each.,a. What is the new market value of the company?,b. How many rights are associated with one new share?,c. What is the ex-rights price?,d. What is the value of a right?,e. Why might a company have a rights offering rather than a general cash offer?,Rights Offering: Example (cont.),a. New value = (250,000,$50) + (50,000,$40),$14.5 million,b. There will be (250,000/ _ ) = _ rights associated with each new share.,c. The ex-rights price is $14.5 million/300,000 = $48.33.,d. The value of one right equals $_,48.33 = $1.67.,What is the Effect of an Equity Offering on Shareholder Value?,Dilution - loss in existing shareholders value,Dilution of proportionate ownership,Dilution of market value,Dilution of book value and earnings per share (EPS),Under what circumstances does market value dilution occur?,Debt vs Equity,Value,of future,cash flows,Contractual int. & principal,No upside,Senior claims,Control via restrictions,Assets,Liabilities,Debt,Residual payments,Upside and downside,Residual claims,Voting control rights,Equity,What if.,Claims,are inadequate?,Returns,are inadequate?,When Debt and Equity are Not Enough,Value,of future,cash flows,Contractual int. & principal,No upside,Senior claims,Control via restrictions,Assets,Liabilities,Debt,Residual payments,Upside and downside,Residual claims,Voting control rights,Equity,Alternatives,Collateralized,Asset-,securitized,Project financing,Preferred,Warrants,Convertible,Equity-Linked Bonds,Bonds with warrants,Convertible Bonds,Index-linked Bonds,These are all example of hybrid bonds and should be priced by decomposition,Stock-Purchase Warrants,Warrants are usually detachable and trade on the securities exchanges,Warrants are often added to a large debt issue as “sweeteners” to enhance the marketability of the issue,Exercise price,Warrants usually have a limited life of about 10 years or less,Warrants differ from rights and convertibles,The Implied Price of an Attached Warrant,To determine the implied price of an attached warrant, the implied price of,all,warrants attached to a bond must be determined,Implied price of all warrants = price of bond with warrants attached - the straight bond value (of similar-risk bonds),The implied price of a single warrant is the implied price of all warrants divided by the number of warrants attached to each bond,The Value of Warrants,A warrant has a “theoretical value” at any point in time prior to its expiration date,The theoretical value can be calculated as:,TVW = (P,o,- E) x N,WHERE:,TVW,= Theoretical value of a warrant,P,o,= Current market price of one share of common stock,E,=Exercise price of the warrant,N,=Number of shares of common stock,obtainable with one warrant,Sony Warrants,Sony Electronics has outstanding warrants exercisable at Yen400/share that entitle holders to purchase three shares of common stock per warrant. If Sonys common stock is currently selling for Y45/share, the TVW =,TVW = (Y45 - Y40) x 3 = Y15,The market value of a warrant is generally greater than its theoretical value; the difference, known as the warrant premium is due to investor expectations and opportunities for further gain before expiration.,Values and Warrant Premium,“Theoretical,Value”,Market,Value,Market Premium,V,a,l,u,e,o,f,W,a,r,r,a,n,t,($),0,Price Per Share of Common Stock ($),1994, HarperCollins,Publishers,Copyright,Convertible Bonds,Bond may be converted into stock,The,Conversion Ratio,is the number of shares of common stock that can be received in exchange for each convertible security,The,Conversion Price,is the per share common stock price at which the exchange effectively takes place,Convertibles,The,Conversion Period,is a limited time within which a security may be exchanged for common stock,The,Conversion Value,is the market value of the security based upon the conversion ratio times the current market price of the firms common stock,Earnings effects:,Firms must report,Primary EPS, treating all contingent securities that derive their value from their conversion privileges or common stock characteristics as common stock,Firms must report,Fully Diluted EPS,treating all contingent securities as common stock,Example: Hyundai Euroconvertible,If Hyundai issues a Eurobond with a $1,000 par value that is convertible at $40 per share of common stock, the conversion ratio =,$1,000,= 25,$40,If Hyundai had stated the conversion ratio at 20, the conversion price =,$1,000,= $50,20,Financing With Convertibles,Motives for using convertibles include:,It is a deferred sale of common stock that decreases the dilution of both ownership and earnings,They can be used as a “sweetener” for financing,They can be sold at a lower interest rate than nonconvertibles,They have far fewer restrictive covenants than nonconvertibles,It provides a temporarily cheap source of funds (assuming bonds) for financing projects,Most convertibles have a call feature that enables the issuer to force conversion when the price of the common stock rises above the conversion price,Determining the Value of a Convertible Bond,There are three values associated with a convertible bond:,Straight Bond Value,is the price at which the bond would sell in the market without the conversion feature,The,Conversion Value,is the product of the current market price of stock times the conversion ratio of the bond,The,Market Value,is the straight or conversion value plus a market premium based upon future (expected) stock price movements that will enhance the value of the conversion feature,Siam Cement,Siam Cement sold a $1,000 par value, 20-year convertible bond with a 12% coupon. A straight bond would have been sold with a 14% coupon. The conversion ratio is 20,Straight Bond Value,$120 x (PVIFA,14%,20,) + $1,000 x (PVIF,14%,20,) =,$120 x (6.623) + $1,000 x (.073) = $867.76,Conversion Value at various market prices of stock,Stock PriceConversion Value,$30 $ 600,40 800,50 (Conversion Price) 1,000 (Par Value),60 1,200,70,1,400,80 1,600,The straight bond value is the minimum price at which the convertible bond would be traded,Values and Market Premium,Straight,Bond Value,Market Premium,V,a,l,u,e,o,f,C,o,n,v,e,r,t,i,b,l,e,B,o,n,d,($) 0,Price Per Share of Common Stock,Conversion Value,Equity Markets and Instruments,What is Equity?,Common,Rights offerings,Hybrids: warrants & convertibles,What Influences Equity Values?,Macroeconomic factors,Industry factors,Firm factors,Fundamental Analysis,Approach to Fundamental Analysis,Domestic and global economic analysis,Industry analysis,Company analysis,Why use the top-down approach?,Framework of Analysis,Portfolio Diversificationand theCapital Asset Pricing Model,Prof. Ian Giddy,New York University,New York University/ING Barings,Equity Risk and Return: Summary,Investors diversify, because you get a better return for a given risk.,There is a fully-diversified “market portfolio” that we should all choose,The risk of an individual asset can be measured by how much risk it adds to the “market portfolio.”,Capital Allocation Possibilities:Treasuries or an Equity F