Symantec Corporation Convertible Notes With Call Spread Case Solution & Answer

Symantec Corporation Convertible Notes With Call Spread Case Solution


In order to get an independent opinion regarding one of the important financing decisions; the Symantec Corporation’s Board of Directors asked Daniel Thompson (who used to work at a global consultancy firm), to provide his independent opinion. As the company had higher equity levels, so the Semantic Corporation was working over plans to raise debt financing in order to repurchase the common shares, while working with different investment banks.

According to appointed consultant, the financing plan deemed very interesting, as the stocks’ repurchase would immediately increasing financial leverage position of Semantic Corporation and the conversion of the notes would reduce the financial leverage significantly at the lowest dilutive cost of the company’s equity.

In addition, Semantic Corporation entered into negotiations with different investment banks for purchasing call spread upon the company’s stock. The consultant kept on pondering over the structure of the transaction and the company’s motivation behind such transaction, after reviewing the whole proposal. The main concerns were to find out the reason behind issuance of convertible stocks and the intention of buying a call spread by the Semantic Corporation (Walid Busaba, 2012).

Problem Statement

By the end of the fiscal year 2006, the Symantic Corporation equity levels reached to 3.22 times of the financial leverage position. The total assets of the company were financed by the 76.3% of equity (See Appendix 1). In order to reduce the equity levels and to increase the financial leverage, the company planned to issue $2.1 billion of convertible notes. The proceeds from the convertible notes would be used by the company to repurchase the common shares. Thompson considered the financing option to be interesting, as it would significantly increase the company’s financial leverage and the conversion of the notes would reduce the financial leverage significantly at the lowest dilutive cost of the company’s equity.

Company Background

Symantec Corporation had remained a market leader of providing security software for personal computers. Norton was the company’s best anti-software product in the market. The company had also expanded in the enterprise IT security, by making different acquisitions. Moreover, the company also increased its product line from anti-virus software to data storage, maintenance and recovery based services. The company’s revenues had increased over the time but the growth in the traditional personal computer industry had remained low, i.e. the revenue growth remained at 6%. In addition, the company’s stock had outperformed the market indices (See Appendix 2). In 2003 and 2004, the company’s stock was split 2-for-1, afterwards, the stock traded at $34 in November 2006.

Question 1

A call spread was negotiated with the initial purchase (also known as hedge participants), over the purchase of a call spread. The main motivation of the behind the call spread was “hedging”, which could result in profits. As we can see in the table below, the Symantec Corporation would buy and sell options with same expiry dates but different prices, resulting in a net profit of $8.2 per option, which would in total be $901.73 for 110 options,

Action Quantity Expiration Strike Type Net
Sell 110 2013 $27.32 Call $27.32
Buy 110 2013 $19.12 Call ($19.12)
Net per option       $8.20
Total         $901.73


In addition, in order to determine the cost and the payoff of the call spread, it is assumed that that the conversion will occur at the options’ expiry date. The option’s purchase price of $19.12 would be the cost for Symantec Corporation, and the company would have to pay the premium to the note holders. The payoffs have been calculated through different spot prices which are explained below

As the options price ranges from $19.12 to $27.3, and if the spot price reaches at $21.5, then the Symantec Corporation would get a zero payoff as the excess return per option would be $2.4, resulting in total of $264 million (i.e. $2.4 x 110 options). But the full cost of Symantic Corporation is $383 million including the bonds premium, which is $3.5 per share. The Symantec Corporation would reach at a breakeven point, if the spot price gets to $22.5. The company will generate a maximum payoff of $4.5 per share if the spot price reaches to $27.3……………………….

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