The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Hedging Dilution Risk
Hedging Dilution Risk
Foreword
Introduction
Theory and Practice of Corporate Risk Management
Theory and Practice of Optimal Capital Structure
Introduction to Funding and Capital Structure
How to Obtain a Credit Rating
Refinancing Risk and Optimal Debt Maturity
Optimal Cash Position
Optimal Leverage
Introduction to Interest Rate and Inflation Risks
How to Develop an Interest Rate Risk Management Policy
How to Improve Your Fixed-Floating Mix and Duration
Interest Rates: The Most Efficient Hedging Product
Do You Need Inflation-linked Debt?
Prehedging Interest Rate Risk
Pension Fund Asset and Liability Management
Introduction to Currency Risk
How to Develop Currency Risk Management Policy
Translation or Transaction: Netting Currency Risks
Early Warning Signals
How to Hedge High Carry Currencies
Currency Risk on Covenants
Optimal Currency Composition of Debt 1: Protect Book Value
Optimal Currency Composition of Debt 2: Protect Leverage
Cyclicality of Currencies and Use of Options to Manage Credit Utilisation
Managing the Depegging Risk
Currency Risk in Luxury Goods
Introduction to Credit Risk
Counterparty Risk Methodology
Counterparty Risk Protection
Optimal Deposit Composition
Prehedging Credit Risk
xVA Optimisation
Introduction to M&A-related Risks
Risk Management for M&A
Deal-contingent Hedging
Introduction to Commodity Risk
Managing Commodity-linked Revenues and Currency Risk
Managing Commodity-linked Costs and Currency Risk
Commodity Input and Resulting Currency Risk
Offsetting Carbon Emissions
Introduction to Equity Risk
Hedging Dilution Risk
Hedging Deferred Compensation
Stake-building
In this chapter we are dealing with the problem of dilution risk. Dilution is a reduction in the ownership percentage that is often undesirable because investors prefer to maintain both the economic benefits of ownership and the voting rights that go with it. A secondary concern with dilution is that it changes the leverage by increasing the proportion of equity, and the resulting equity may be suboptimal from the capital structure perspective (see Chapter 7).
Dilution may occur through issuance of new shares or when holders of share options, such as convertible securities or participants in the ESOPs, exercise their options. In both such situations, dilution can happen only if the option is settled physically – ie, through shares. If, however, the settlement is in cash, there is no dilution risk. This chapter deals with a commonly encountered example of dilution risk resulting from convertible bond issuance.
BACKGROUND
Metalco is a USD-reporting metal manufacturer. Some time ago, it issued a convertible bond with the parameters shown in Table 41.1.
The bond can be converted into shares at a ratio of 1.4285 shares for one bond. For example, if, at the start of the
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