No abstract

This study analyzes bank margins in the German secondary market for exchange‐traded structured financial products, with particular emphasis on the influence of banks' credit risk. A structural model allowing for the incorporation of correlation effects between market and credit risk is applied to compare quoted and fair theoretical prices. For discount certificates, as the most popular type of structured financial products in Germany, an empirical study is conducted. Compared to earlier studies, total margins are found to be rather low, whereas the portion that draws back to credit risk appears to be a material part of the total margin. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28: 376–397, 2008

We develop a model for the demand of warrants by individual investors with regard to their sensitivity to issuer margins, defined as the relative overpricing with respect to the theoretical value. Based on an empirical data set we show that investors are relatively margin-sensitive; that is, given similar warrants from different issuers or warrants with similar characteristics, investors tend to buy those with the lowest margin. Investors are, however, not absolutely margin-sensitive; that is, demand is not influenced by the overall margin level. Our model suggests an equilibrium with different issuer pricing strategies for different warrants in such a situation. Consistent with the model's predictions, we find that issuers vary their pricing with the moneyness of a warrant. We thus give an explanation for the dependence of issuer margins on a product's moneyness, which has been documented in the literature for several retail derivative products.

No abstract

We propose a method to estimate the cost of debt in a continuous-time framework with an infinite time horizon. The approach builds on the class of wellknown earnings before interest and taxes (EBIT)-based models. It extends other approaches based on option-pricing theory with a finite one-period horizon. The model is capable of splitting the observed yield spread of a corporate bond into the risk premium, which adds to the expected return of bondholders, and the default premium, which accounts for expected losses. The model can easily be calibrated for non-public firms, since most of its input parameters are readily observable, while the output, the model-implied cost of debt, proves to be very insensitive with respect to the remaining non-observable parameters, the EBIT growth rate, and the bankruptcy costs of the firm. We demonstrate the applicability of the cost of debt to calculate an approximate weighted average cost of capital for the purpose of firm and project valuation, and its usage and limitations.