《金融工程》案例10-RJR

FinancialEngineeringCasesinFinancialEngineeringInstructor:ChenMiaoxinFinancialEngineering2TheCaseofRJRNabiscoHoldingCapitalCorporationFinancialEngineeringReference:RobertM.Dammon,KennethB.Dunn.AndChesterS.Pratt.1993.TheRelativePricingofHigh-YieldDebt:TheCaseofRJRNabiscoHoldingsCapitalCorporation.theAmericanEconomicReview,83(Dec.)FinancialEngineeringPartOne:BackgroundFinancialEngineering5Background1Thefirmknownin1991asRJRNabiscowasadescendantofthetobaccofirmR.J.Reynolds,foundedin1875.Throughacquisitionsinthe1960s,thetobaccofirmenteredavarietyoffoodbusinesses.Afterits1985merger,thefirmwasrenamedRJRNabisco.FinancialEngineering6Background2Inthelate1980sthefoodproductsindustryexperiencedmassiveconsolidationthroughmergers.In1988twomainbiddersproposedtotaketheRJRNabiscoprivateinaleveragedbuyoutcontest:–TheManagementGroup–Kohlberg,Kravis,Roberts&Co.(KKR),afirmspecializinginleveragedbuyoutsFinancialEngineering7Background3Attheendofabiddingwar,KKRprevailedbyofferingshareholders$81pershareincashplusapackageofbondsvaluedat$28.ThedaybeforethefirstannouncementofapossibletakeoverforRJRNabisco,itsstockhadtradedat$77.25.Thus,KKRofferedcommonshareholdersa41%premiumoverthefirm’spre-takeovervalue.Tofinancethebuyout,KKRincreasedRJR’sdebtfrom$5billionto$29billion.FinancialEngineering8Background4Thenewfirmwasstructuredasaseriesofholdingcompanies.Eachoftheserelatedentitieshadseparateobligations,issuedeitherinconjunctionwiththeacquisitionor,inthecaseofRJRNabisco,Inc,theoperatingcompany,carriedoverfromthetaken-overfirm.FinancialEngineeringPartTwo:DescriptionofSecuritiesFinancialEngineering10IssuanceInMay1989,RJRholdingsCapitalCorporationissuedthreenearlyidenticaldebtsecuritiesinconnectionwiththeleveragedbuyoutofRJRNabiscobyKKR–$1.0billionof15-percentpayment-in-kindsubordinateddebenturesdue2001(pay-in-kindbond)–$4.1billionofsubordinateddiscountdebenturesdue2001(deferred-couponbond)–$525millionof13.5-percentsubordinateddebenturesdue2001(cash-payingbond)FinancialEngineering11FinancialEngineering12FinancialEngineering13DifferenceThemajordifferenceamongthethreesecuritiesistheforminwhichinterestispaid.FinancialEngineering14Thedifference1The13.5-percentcash-payingbondpaysinterestincash.Thebankruptcyclaimofthecash-payingbondisparplusaccruedinterest.FinancialEngineering15Thedifference2AfterMay15,1994,thedeferred-couponandpay-in-kindbondsbecomeidentical15-percentcash-payingbonds.PriortoMay16,1994,interestonthe15-percentpay-in-kindbondmay,attheoptionofRJR,bepaideitherincashorthroughtheissuanceofadditionalpay-in-kindbondsvaluedat100percentofpar.Thebankruptcyclaimofthepay-in-kindbondisparplusaccruedinterest.FinancialEngineering16Thedifference3Thedeferred-couponbondwasissuedonMay15,1989,atapriceof$48.656per$100offacevalue.ThroughMay15,1994,thedeferred-couponbondpaysnocouponbutaccretestofacevalueonMay15,1994,atarateof15percentperyear,compoundedsemiannually.PriortoMay15,1994,thebankruptcyclaimofthedeferred-couponbondisitsaccretedvalue.FinancialEngineering17FinancialEngineering18Thedifference4Thedeferred-couponbondandpay-in-kindbondstradeflat(i.e.,withoutaccruedinterestdueuponsettlement)priortoMay15,1994,whilethesettlementpriceofthesetwobondsisthequotedpriceplusaccruedinterestafterMay15,1994.Thesettlementpriceofthe13.5-percentcash-payingbondisalwaysitsquotedpriceplusaccruedinterest.FinancialEngineeringPartThree:TheoreticalPricingRestrictionsFinancialEngineering20NotationAssumption:therearenomarketimperfections.Wedenotethequotedprice(per$100offacevalue)attimetof–thecash-payingbondby–thedeferred-couponbondby–thepay-in-kindbondbyWeletvtdenotethesettlementprice(i.e.,thequotedpriceplusaccruedinterest)attimetofabondwhosequotedpriceispt.ctpdtpptpFinancialEngineering21PriortoMay15,1994Sincethedeferred-couponandpay-in-kindbondstradeflatpriortoMay15,1994,fort≤T*,whereT*isMay15,1994.ddttppttvpvpFinancialEngineering22AfterMay15,1994AfterMay15,1994,boththedeferred-couponandpay-in-kindbondsbecomeidentical15-percentcash-payingbonds.Inadditiontopayingalowercoupon,the13.5-percentcash-payingbondalsohasalowercall-priceschedule(seetable2)thaneitherthedeferred-couponorpay-in-kindbonds.Asaresult,thefollowingarbitragerestrictionmustholdafterMay15,1994:wheretheinequalityassumedtheabsenceofrefinancingcosts.*(1)cdptttvvvfortTFinancialEngineering231.Deferred-couponandcash-payingbondsConsideraportfolioconsistingofonedeferred-couponbondandU.S.Treasurystripswithfacevaluesof$6.75thatmatureateachofthecouponpaymentdatesthroughMay15,1994.FinancialEngineering24Cont.BeyondMay15,1994,thedeferred-couponbondismorevaluablethanthecash-payingbondduetoitshighercouponandcall-priceschedule[seeequation(1)].PriortoMay15,1994,theportfolioofonedeferred-couponbondplustreasurystripshasthesamepromisedpaymentsasthecash-payingbond,butlessdefaultriskbecausethepaymentsontheTreasurystripsareriskless,whereastheinterestpaymentsonthecash-payingbondarerisky.FinancialEngineering25Cont.Therefore,whereqitistheTreasury-strippriceattimetforadollarofpaymentattheithcouponpay