36 lines
2.3 KiB
Plaintext
36 lines
2.3 KiB
Plaintext
636 Part V: Index Options and Futures
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Adding up all eight of these, it is determined that the present worth of all the
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remaining additional dividends is $2.81. Note that this is less than the actual amount
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that will eventually be paid over the two years, which is $3.00.
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Now, using the simple formula given earlier, the value of the imbedded call can
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be determined:
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XYZ: 32
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PERCS: 34
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Present worth of additional dividends: 2.81
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Imbedded call = Stock price + pw divs - PERCS price
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= 32 + 2.81 - 34
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= 0.81
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Once this call value is determined, the strategist can use a model to see if this call
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appears to be cheap or expensive. In this case, the call looks cheap for a two-year call
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option that is 7 points out-of-the-money. Of course, one would need to know how
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volatile XYZ stock is, in order to draw a definitive conclusion regarding whether the
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imbedded call is undervalued or not.
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A basic relationship can be drawn between the PER CS price and the calculated value
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of the imbedded call: If the imbedded call is undervalued, then the PERCS is too
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expensive; if the imbedded call is overpriced, then the PERCS is cheap. In this exam
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ple, the value of the imbedded call was only 81 cents. If XYZ is a stock with average
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or above average volatility, then the call is certainly cheap. Therefore, the PERCS,
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trading at 34, is too expensive.
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Once this determination has been made, the strategist must decide how to use
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the information. A buyer of PER CS will need to know this information to determine
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if he is paying too much for the PER CS; alternatively stated, he needs to know if he
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is selling the imbedded call too cheaply. A hedger might establish a true hedge by
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buying common and selling the PERCS, using the proper hedge ratio. It is possible
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for a PER CS to remain expensive for quite some time, if investors are buying it for
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the additional dividend yield alone and are not giving proper consideration to the
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limited profit potential. Nevertheless, both the outright buyer and the strategist
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should calculate the correct value of the PER CS in order to make rational decisions.
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PERCS SUMMARY
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A PERCS is a preferred stock with a higher dividend yield than the common, and it
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is demandable at a predetermined series of prices. The decision to demand is strict
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ly at the discretion of the issuing company; the PER CS holder has no say in the deci- |