Example: Estimating debt ratios (MV) with complex ... Kmar

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Long term financing

• Chapter 12 2,5,8,13,15
• Chapter 13 6,8,16,23
• Chapter 14 1,3,9,11
• Chapter 20 6,12,16

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Characteristics of stock vs. debt

• Debt vs. Equity
• Residual claim?
• Payments are tax deductible?
• Finite life?
• Voting rights?
• Hybrid securities (preferred)

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Characteristics of debt securities

• Security
• Seniority
• Callable
• Convertible
• Covenants
• Credit rating

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Example Estimating debt ratios (MV) with
complex capital structures

• Kmart is trying to estimate its debt ratio. It
  has 1 million shares outstanding, trading at 50
  per share, and 250 million in straight debt
  outstanding (with a yield ot maturity of 9). It
  also has two other securities outstanding
• 1) it has 200,000 warrants outstanding,
  conferring on ints holders the right to buy stock
  at 65 per share. These warrants are trading at
  12 each.
• 2) It also has 10,000 20-year convertible bonds
  outstanding, with a coupon rate of 6 and 10
  years to maturity. These bonds trade at par.
• Estimate the debt ratio in market value terms.

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Example Value of convertible bonds

• At the end of 2003, GM had an 8.25 convertible
  bond, coming due in the year 2011, which was
  trading at 1400. It also had straight bonds,
  with the same maturity, trading in December 2003
  at a yield of 8.4. What is the value of the
  conversion option?

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Corporate bond yield spreads
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