Risk Premium Approach

Under the risk premium approach, a risk premium is added to the yield (YTM) on the company's bonds (to reflect the higher risk borne by shareholders) to estimate cost of equity. That is, cost of equity Bond yield + risk premium. The equity risk premium can be calculated in two ways - historic yield spread method and ex-ante yield spread based on DCF analysis. The historic risk premium is the difference between the average of annual returns on a stock index in the past (say 10 years) and the...

Accounting Based Debt Covenants

Debt covenants, also called banking covenants or financial covenants, are agreements between a company and its creditors that the company should operate within certain limits. A covenant is an agreement or promise to do or not to do a particular thing, to enter into a formal agreement a promise incidental to a deed or contract. The functional objectives guiding most covenants are full disclosure of information, preservation of net worth, maintenance of asset quality, maintenance of adequate...

Investing in Exotic Options

15.1 Chapter Introduction and Objectives In Chap. 14, we introduced the pricing of plain vanilla call and put options on dividend paying and nondividend paying stocks. In this chapter we introduce the pricing of exotic options. This chapter has the following objectives Introduce different types of exotic options Discuss the pricing of Barrier, Look back, Binary, Asian, and spread options Exotic options are a class of derivative products, which allow the buyer (or seller) of the option to...

Prospective Analysis Guidelines for Forecasting Financial Statements

Ignacio Velez-Pareja and Joseph Tham 8.1 Chapter Introduction and Objectives Having performed an accounting and financial analysis, an analyst has to forecast financial statements into the future. This is a precursor to valuation. Many methods of forecasting like percent sales method are available. In this chapter, we provide a comprehensive overview of prospective analysis. Although parts of the chapter are written from the perspective of a company's manager, they are still valid for an...

Defining Pure Active Return and Risk What Should Managers Be Hired to Deliver

We agree on the separation of market or policy risk and pure active risk, in principle. Let's go one step further and apply it in practice, separating these gross components of market risk (and return) and pure active risk (and return) in a real world context. The returns that usually pass for alphas - the simple differences between the benchmark return and the manager's return - are properly known just as active returns (without the pure). But these simple active returns might have more or...

Valuation of Convertible Bonds Nyborg 1996

A convertible is a combination of debt and equity option. So, the value of a convertible is the sum of the straight debt and option components. The option embedded in a convertible is an American-type option, not European because the investor can convert any time up to maturity. When pricing a convertible bond, analysts use a two-step process. First, compute the pure bond value of the convertible. This is equal to the net present value of the stated coupons and redemption value, using a series...

References

Amram M, Kulatilaka N 1999 Real options managing strategic investment in an uncertain world. Harvard Business School Press Amram M, Kulatilaka N 1999 Disciplined decisions aligning strategy with financial markets. Harvard Business Review Amram M, Kulatilaka N 1999 Uncertainty the new rules for strategy. J Business Strategy Amram M, Kulatilaka N 2000 Strategy and shareholder value creation the real options frontier. J Appl Corp Finance 13 2 Brennan MJ, Schwartz E 1992 A new approach to...

Nec

The terms of the NEC issue are given in Appendix 2 at the end of the chapter. In addition to the Trust Preferred Securities, NEC offered 100 billion Yen of Euro Yen Convertible Bonds mainly to institutional investors in the Euro market. The terms of the NEC issue are presented in Appendix 3. Mandatory convertibles are equity-linked securities that pay a higher dividend compared to the company's common stock for a certain number of years and then get converted into common shares on a specified...

Warrants

A warrant is an option that gives the holder the privilege of buying a specified number of shares of the company at a specified exercise price at any time on or before the expiration date. Warrants usually come as attachments to bonds to make an issue more attractive to investors. The debenture holder can exercise a warrant. Warrants can also be detached and separately listed on a stock exchange for trading purposes. The issuer of the warrant receives the price of the warrant at the time of...

Types of Capitalism

Broadly, there are two types of capitalism arm's length system e.g., U.S, U.K and relationship-based system e.g., Germany, Korea . In an arm's length market-based Anglo-Saxon system, a financier is protected by explicit contracts as opposed to a relationship-based system, which is largely self-governing parties honor agreements to maintain their reputation. In market-based system, relationship matters less. In a relationship-based system, the lending bank has a close long-term relationship with...

Contributors

Paul Ali is an Associate Professor in the Melbourne Law School and a member of the Law School's Centre for Corporate Law and Securities Regulation. He has published widely on banking and finance law, corporate governance and institutional investment law, securitization law, and structured finance law. In 2006, he was appointed by the Federal Attorney-General as a member of the Personal Property Securities Review Consultative Group. He is currently undertaking research in connection with a...