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The Impact of Warrants and Convertible Securities on the Systematic Risk of Common Equity
Author(s) -
Ehrhardt Michael C.,
Shrieves Ronald E.
Publication year - 1995
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.1995.tb00859.x
Subject(s) - convertible bond , convertible arbitrage , equity (law) , equity risk , systematic risk , convertible , equity capital markets , capital structure , business , common stock , volatility (finance) , cost of capital , economics , debt , financial economics , finance , private equity , capital asset pricing model , profit (economics) , paleontology , context (archaeology) , structural engineering , arbitrage pricing theory , political science , risk arbitrage , law , biology , microeconomics , engineering
This paper addresses the relationship between the capital structure and the systematic risk of common equity for a firm whose capital structure includes convertible securities. Adding warrants to the capital structure reduces the systematic risk of equity, which is consistent with the fact that warrants dampen the volatility of equity by reducing the upside potential gains of existing stockholders. Expressions showing the impact of conversion features in debt and preferred stock on the systematic risk of equity are derived, and contrasted with the systematic risk effects of non‐convertible debt or non‐convertible preferred stock financing. Failure to incorporate conversion features may lead to serious errors in assessing the impact of financing alternatives on the risk of equity.