Right and Warrant

Presented by Duong Thi Thuy An

Group task
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What is Preemptive Right? Characteristics of Preemptive right? Why would a shareholder should participate in a Right offering? What is Warrant? Characteristics of Warrant? Why would an investor hold a warrant? Listing all kind of derivatives you know. Please give briefly definition on each derivative. What is Option? Please give details about kinds of option?

Rights (Preemptive rights)

Right to purchase shares means securities issued by the joint stock companies together with an additional share issuance in order to secure that the existing shareholders will have the right to buy new shares according to the determined conditions. Characteristics: Only for common shareholder Not raising capital Subscription price is lower than market price of common stock Short term: within 20 or 30 days

Underlying assets (for rights):

o Common shares o Preferred shares

o Preference shares o Convertible shares

o Preferred convertible shares o Preference convertible shares o Bonds

o Others

Exercise: Rights Issue

Company ABC has 1,000,000 shares outstanding Mr. X owns 10% of those shares, i.e., 100,000 shares

If ABC wants to issue 200,000 new shares, what would be the characteristics of the rights issue it should launch? How many rights would Mr. X receive?

Valuing a Right
C0: market price before new issue C1: market price after new issue N: Number of outstanding stock before new issue n: Number of new issue shares D: price of right P: subscription price

N .C0 n. p C1 n N n D (C1 p ) N n D (C0 p ) n N

Example
ABC company: 30.000 outstanding stocks, market price: $20 New issue: 10.000 stocks, subscription price: $17 Rights value? If the market price after the new issue is $23, find rights value With $1000 initial investment, please calculate rate of return of 2 projects: investing in stock and investing in preemptive right?

Why Would a Stockholder Participate in a Rights Offering?

Stockholders have an incentive to exercise their rights or otherwise be diluted (in ownership percentage, or price per share, or both) by the issuance of new equity. Dilution effect:

Discount % D.E % 1 Exercise _ ratio

Warrants
Warrants means securities issued together with the issuance of preference shares or bonds, permitting the securities holder to buy a certain amount of common shares at the pre-determined price during a certain period of time.
Warrants are employed as sweeteners

Underlying assets (for warrants):

o Basket (of assets) o Equities

o Debt instrument/Interest rates o Commodities

o Currencies o Indices o Others

Warrant-Characteristics
Strike price > market price Long-term Issued by firm. When a warrant is exercised, firm gives share to warrants holder result an increase in number of shares If strike is below market value, this dilutes value of existing shares Issued as part of a package of new securities

Warrant
The warrant contains provisions for:
the number of shares that can be purchased per warrant. the price at which the warrant can be exercised. the warrant expiration date.

Warrant holders are not entitled to any dividends nor do they have any voting power.

Example
FunFinMan, Inc., is currently financed entirely with common stock. The firm is composed of $10 million in common stock ($5 par value) and $20 million in retained earnings. The company is considering issuing $10 million of 8%, (Face value=$500), 20-year debentures including 1 warrant per bond that can be converted into 5 shares of common stock at an exercise price of $40 per share. How will this impact the capitalization of the firm?

Derivatives

A derivative is a contract, the value of which is derived from an underlying asset

*OTC = Over the counter

Exchange-Listed Derivatives

Options are contracts that grant to the holder the privilege to purchase or the privilege to sell the assets specified at a predetermined price or formula at or within a time in the future

Futures are contracts that obligate the buyer to purchase and the seller to deliver in the future the assets specified at an agreed price

OTC Derivatives

Forwards are similar to futures contracts, but they are not standardized and are negotiated over-the-counter between two individuals Swaps are over-the-counter derivatives, through which two parties agree to exchange cash flows in the future

OTC Options are options that are negotiated over the counter, implying they are not standardized or guaranteed by an exchange Others, i.e., the number of OTC derivatives possible is practically unlimited

Options

Options by Type

Call Option Contract between a buyer (holder; long position) and a seller (writer; short position) giving the buyer the right, but not the obligation, to buy the assets specified at a fixed price or formula on or before a specified date

The seller of the call option assumes the obligation of delivering the assets specified, should the buyer exercise his option.

Options by Type

Put Option - Contract between a buyer and a seller giving the buyer (holder) the right, but not the obligation, to sell the assets specified at a fixed price or formula on or before a specified date The writer (seller) of the put option assumes the obligation of buying the assets specified should the holder exercise his option Others (Miscellaneous) Options that do not fit into either of the other categories

Attributes of Options

Type of scheme:
o American - The option can be exercised at any time
between its issuance and expiration date; majority of exchange-traded options are American

o European - The option can only be exercised on its

expiration date; over-the-counter options are often European

o Bermudian The option can be exercised on a set

number of days before expiration date, e.g., one day per week

Attributes of Options

Underlying Assets: o Basket of assets o Equities o Interest rate/notional debt instrument o Commodities o Indices o Options o Futures o Swaps (Swaption) o Others

Attributes of Options

Delivery - Physical or cash Standardized/non-standardized - Standard or nonstandard contracts

Spot Price vs. Strike Price

The spot price is the price of an asset for immediate delivery

The strike price is the price at which the asset may be bought or sold in an option contract. Also called the exercise price

How do options work?

Siemens @ 75 EUR 100 100

Gain

75 = Spot Price
Loss

75

50 Today To speculate on 1,000 shares of Siemens without an option, you could buy the shares today and pay 75,000 EUR (e.g., if the price drops to 60 EUR, you would lose 15,000 EUR)

50 Today + 6 Months

How do options work?

100 Siemens @ 75 EUR
Spot Price

100

Strike Price

75 = Spot Price

Gain

75

Loss = Max. 500 EUR

Spot Price

50 Today

50 Today + Or you buy a call option for a small premium 6 Months (e.g., 0.50 EUR per share), which costs (e.g.) 500 EUR; if the spot price on the exercise date is above the strike price, you win; if it is below, your loss is limited to 500 EUR

Strike Price

Option- Value

In the money: Option has value when exercised Call: strike price< current market price of stock Put: strike price> current market price of stock Out of money: Option has no value when exercised Call: strike price>current market price of stock Put: strike price< current market price of stock At the money: no profit or loss when exercised option Call and Put: strike price= current market price of stock.

Option- Value
Intrinsic value: the difference between strike price and market price of stock. Time value:When an options priceits premiumexceeds its intrinsic value, the option is said to have time value. When the option is at-themoney or out-of-the-money (and thus has no intrinsic value), the entire premium is time value. When the option is in-the-money, the amount by which its price (the premium) exceeds its intrinsic value is time value .

Example
MICROSOFT Call Expiration March April July October March April July October March April July October March April Strike price 24 24 24 24 25 25 25 25 26 26 26 26 27 27 Last 5.3 5.5 ... ... 4.25 4.45 4.75 ... 3.25 3.35 3.75 ... 2.38 2.53 ... 877 12613 ... 70 72 7 ... ... 140 3 15 Vol 21 35 Current stock price Put Open Last Vol Open Interest Interest 876 ... ... 744 2661 0.04 1 11227 417 0.27 50 1340 16 0.63 28 2592 861 ... ... 3762 21642 0.04 77 19620 2289 0.37 92 49685 123 0.8 35 592 1941 ... ... 9966 8760 0.08 37 19534 1676 0.53 6 18711 111 0.98 45 1008 8130 0.01 157 24469 54735 0.12 717 20736 29.37

Last price on 16/03/2010

How options are created?

It takes both a seller and a buyer to create an option. The buyer (who is said to be long the option) and the seller (also known as the writer of the option) have opposite opinions as to the future price movement of the underlying stock.

Exercise: Options

How much would the profit/loss be on 10 call contracts (100 shares per contract) for shares of IBM with a strike price of 82.5 USD per share, if the premium paid was 3.75 USD and the spot price of IBM on strike date is 87.25 USD?

How much would the profit/loss be, if the spot price of IBM on strike date is 83.125 USD?

Equity Options

Contracts that give the holder the right to buy or sell a specified number of shares of an equity at a specified price for a certain (limited) time period One option contract typically represents 100 shares of the underlying equity (on Eurex, most of Euronext [except LIFFE] and U.S. exchanges) or 1,000 shares (on LIFFE)

Index Options

Index options are created by assigning a monetary value to a point in an index, then the calculating point difference between spot and strike prices Settlement of index options is always in cash, rather than by delivering the portfolio underlying the index

For example, the FT-SE 100 index option:

o Index point value = 10 GBP per point
o Tick size = 0.5 point o Tick value = 5 GBP

Other Types of Options

Currency Options
o Mostly traded over-the-counter, but some exchange
trading

o The size of one contract depends on the currency

Interest Rate Options Based on interest rate levels Bond Options Underlying asset is a specific bond Options on Futures Options to acquire futures contracts

Swaptions Options that entitle the holders to enter into pre-defined swaps