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1. Option value consist of intrinsic value and time value. Risk free rate is one of the component of time value and the textbook says that “the higher interest interest rates the lower present value of the exercise price. This reduces the cost of exercising and thus adds value to the current call option value”. What does this mean ?….
2. Among the reasons why mergers/acquisition fail, why do “cheap purchases and “paying too much” lead to failure of mergers/acquisition ?
For cheap purchases – if a company acquires the other cheaply, isn’t beneficial ? assuming that the value is not substantially low
for paying too much – if a company pays a lot ( not excessively), isn’t goodwill value will be high ? leading to high asset for the acquiring company ?3. Sometimes in the revision kit, they have used the term long and short. Can we understand long as “buy” and short as “sell” ??? and we don’t necessarily have to use these terms in exams right ?
4. For the reconstruction of solvent companies, for “conversion of debt to equity” textbook says that most likely reasons for converting debt to equity are – automatically by holders of convertible debentures exercising their rights
Does it mean that companies are forcing convertible debenture holders to exercise their rights ?1. You will know from my free lectures on option pricing that one factor in the Black Scholes formula is the interest rate and that effectively it is discounting over the period to maturity. Discounting at a higher rate always results in a lower PV and this in case a lower premium.
2. Paying too much means paying more than the company is worth (even including any goodwill). If you pay too much then it is clearly a possible reason for the acquisition to fail. Paying too little is potentially beneficial, but if you are buying at an unrealistically low price (and the offer is accepted) then it suggests that something is wrong with the company being acquired.
3. Correct, and there is no need to use the terms.
4. No, not forcing. The terms of most convertible debt are that holders can convert at any time up to a certain date in the future. Most likely is that they are choosing themselves to convert.
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