Solutio of Gitman's Finance.Doc

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Special Topics
Managerial Finance


16Hybrid and Derivative Securities

17Mergers, LBOs, Divestitures, and Business Failure

18International Managerial Finance


Derivative Securities



This chapter focuses on other sources of long-term financing: leasing, convertible bonds, convertible preferred stock, and warrants. The basic features, costs, and advantages of these financing methods are discussed. The basic types of leases (operating and financial), leasing arrangements, and legal aspects of leasing are presented, as well as the procedure used to analyze a lease versus purchase decision. The student learns how to evaluate convertible securities and stock-purchase warrants. The use and features of stock options are presented. The chapter concludes with a discussion of the use of options to hedge foreign currency exposure.


This chapter's topics are not covered on either the PMF Tutor or the PMF Problem-Solver.

PMF Templates

A spreadsheet template is provided for the following problem:


Study Guide

The following Study Guide examples are suggested for classroom presentation:

3Stock warrants
4Lease-versus-purchase analysis

16-1Hybrid securities contain characteristics of both debt and equity. Hybrid securities are a form of financing used by the firm. Derivative securities are neither debt nor equity. They are securities that derive their value from another "underlying" asset. Derivatives are not used by the firm for raising funds but are used for managing certain aspects of the firm's risk.

16-2Leasing is a financing technique that allows a firm to obtain the use of certain fixed assets by making periodic, contractual payments that are tax deductible. An operating lease is a contractual agreement whereby the lessee agrees to make periodic payments to the lessor for five or fewer years for an asset's services. Such leases are generally cancelable at the option of the lessee, who may be required to pay a predetermined cancellation penalty. Assets leased under an operating lease, such as computers, generally have a usable life longer than the term of the lease. Therefore, normally the asset has a positive market value at the termination of the lease. Total lease payments are generally less than the cost of the leased asset. A financial (or capital) lease is a longer-term lease than an operating lease. It is noncancelable and therefore obligates the lessee to make payments for the use of an asset over a predefined period of time. Financial leases are commonly used for leasing land, buildings, and large pieces of equipment. The noncancelable feature of this type of lease makes it quite similar to certain types of long-term debt. The total payments under a financial lease are normally greater than the cost of the leased assets to the lessor. In this case the lease period is closely aligned to the asset's productive life.

The FASB Standard No. 13 defines a capitalized (financial) lease as one having any of the following four elements: (1)transfer of property to the lessee by the end of the lease term; (2)a purchase option at a low or "bargain" price, exercisable at a "fair market value;" (3)a lease term equal in length to 75 percent or more of the estimated economic life of the property; (4)the present value of lease payments at the beginning of the lease equal to 90 percent or more of the fair market value of the leased property, less any investment tax credit received by the lessor.

Three methods used by lessors to acquire assets to be leased are: (1)a direct lease - the lessor owns or acquires the assets that are leased to the lessee.

(2)a sale-leaseback...
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