Warrant is long term right in which warrant holder can purchase certain number of common stock at pre-determined price within specific duration. It is right option to buy the common stock not the obligation. It is also called sweeter because it makes debt and preferred stock more attractive and marketable. Warrant is an instrument that can be traded on the stock exchange like stocks and bonds.
A call or put warrant allows the holder to purchase or to sell an underlying asset at a set price (strike price or exercise price) by a specified date, but does not obligate him or her to do so. It expires on that date. There are some that can be used before that date and others that can only be used during that time frame. It is typically less costly than the underlying asset, referred to as the “premium.”
➦ Convertible is one the feature of carried out by bonds, debenture and preferred stock which gives the option to the bondholders or stockholders to convert the shares into common stock.
➦ Convertible securities are the bonds, debentures and preferred stocks having convertible features are converted into common stock under pre-specified terms and conditions which is clearly mentioned at the time of issuance of these securities.
➦ Convertible securities receive fixed return on and additionally get option of conversion.
➦ Convertible securities are issued to reduce cost of capital, increase the marketability, avoid dilution and deferred equity financing.
➦ Securities having convertible features are generally sold with less coupon rate or dividend rate than securities having no convertible feature.
➦ Some firm may have poor financial status but have future growth at that time firm can sell convertible securities at higher price than prevailing price.
➦ With the help of convertibles firm control the control position. Securities having convertible feature are more attractive than without convertible feature.
➦ Modigliani and Miller commonly known as MM theory is most acceptable and widely used capital structure theory which support NOI approach and criticize the Net Income theory and Traditional theory of capital structure.
➦ Franco Modigliani and Merton Miller jointly worked on this theory originally published in 1958 entitled “The cost of capital, Corporation finance and the theory of Investment”, received Noble Prize for their contribution.
➦ They argue cost of capital and value form remains constant irrespective of change in capital structure.
➦ MM approach theory of capital structure is categorized as proposition I and proposition II.
Net Operating Income theory is called irrelevant theory since it assumes that the only capital structure change cannot affect the cost of capital and value of the firm. According to this theory irrespective of capital structure overall cost of capital will be constant, so total value of firm also remains unaffected when capital structure is changed.
As the leverage ratio is increased firm becomes more risker and leads to linear increment of cost of equity but overall cost of capital remains constant.
Traditional Approach | Capital Structure Theories | Relevant Theory | Corporate Finance Traditional Approach Traditional approach is extended form of Net Income approach. Net Income approach only talks about the effect of leverage on value of firm and cost of capital but does not talk about the Optimal Capital Structure. Optimal Capital structure … Read more
Net Income Approach | NI Approach | Capital Structure Theories | Corporate Finance Net Income Approach Net Income approach of capital structure theory assumes that the only capital can affect the value of firm and overall cost of capital. According to Net income theory, proposed by David Durand in 1952, Capital structure is relevant to … Read more
Capital Structure Theories | Net Income (NI) approach | Traditional Approach | Net Operating Income (NOI) Approach | Modigliani and Miller (MM) Approach | Capital Structure | Corporate Finance
Capital Structure
Any business organization needs funds to run their business organization. Sources of funds can be broadly classified as the short term sources and long term sources. Combination of these long term and short term sources is called financial structure of the firm but capital structure is the mixture of only long term debt and equity capital.
There are different debt instruments and ownership capital instruments are available in capital market. i.e. bond, promissory notes, preferred stocks, retain earnings, common stocks. Different instruments have different cost, different risk and different benefits.
One of the crucial financing decisions is the decision of proportion of debt and equity that is concerned with the effect of mix of capital sources on its overall cost and valuation of the firm. There are four theories on capital structure which can be classified as irrelevant theory and relevant theory.
Relevant theories explains how the capital structure affects the value of firm and irrelevant theory criticize the relevant theories and explains how capital structure is irrelevant in determination of value of firm based on certain assumptions.
Above mentioned theories are based on some assumptions. They are as follows:
i. There are only two sources of financing i.e. common stock and long term debt. ii. The issue of additional common stock is used to redeem debt and the issue of additional debt is used to repurchase common stock. iii. All earnings are distributed as dividend that means dividend payout ratio is 1 and retention ratio is zero. iv. The debt is assumed to be perpetual and no existence of flotation cost at the time of issuance of securities. v. The firm operating income (EBIT) is assumed to be constant. vi. No existence of tax. vii. The firm is not exposed to the risk of financial distress and hence there is no bankruptcy cost.
Difference between Debit Card and Credit Card | Payment System
Debit Cards are the ATM Cards used by the accountholders to withdraw certain amount of cash if they have sufficient amount of balance in their account. Credit Cards are the ATM Cards used even by the non-accountholders to withdraw certain amount of cash in the form of loan as per the standing instructions ,even if the bank balance is insufficient.
Difference between Commercial Bank and Development Bank
Banks that are involved in currency exchanges, saving deposits, lending loans and other form of commercial transactions are considered as Commercial Banks.
Banks that are mainly established to develop infrastructure of the country by providing financial ,technical, administrative and managerial assistance for special sector are considered as Development Banks.
Stock Dividend | Why do companies give stock dividends? | Financial Management | Management Notes What is a stock dividend ? Companies do pay dividend to its existing shareholders in the form of cash or additional shares of common stock or both. When the companies pay dividends to its existing shareholders in the form of … Read more
Stock Split | What is a stock split | Financial Management | Management Notes Stock Split is the action taken by the company to increase the firm’s number of outstanding shares in the market because of the falling share price of the company by reducing the par value of share in the market. Unlike in … Read more
