Axiom Valuation provides expert and cost-effective custom valuation services for derivative securities, such as stock options and warrants, for established companies.
Valuing Derivative Securities
Derivative securities include stock options, warrants, rights, convertible debt, and convertible preferred stock. These securities confer a right to buy or sell an underlying asset, typically a financial security like a stock or bond, at a fixed price within a designated period of time. Derivative securities are typically valued using a version of the Black-Scholes Option Pricing Model.
The two key inputs in valuing derivative securities are the price of the underlying asset and the volatility of the asset’s return. If a stock option is being valued, for example, the price of the underlying asset is the stock price. If a public firm issued the stock, then the price of the underlying asset, that is, the stock price, can be easily determined from the public exchange where the stock is traded. The volatility of the asset’s return is generally measured as the standard deviation of the stock’s return. The inputs needed to implement this model are often difficult to calculate and, therefore, the calculation requires careful and diligent analysis to ensure consistency between the value of the derivative in question and the value of its underlying asset.
Valuing Derivative Securities for a Privately Held Firm
Additional complexity is introduced when valuing derivative securities where the underlying assets consist of stock in a privately held firm. First, the value of the firm’s shares must be determined with the appropriate adjustments for lack of liquidity for a private firm. The accuracy of the derivative valuation will be directly dependent on the accuracy of the calculated share value.
Next, since there is no publicly traded stock from which to measure the volatility of the return, the valuation expert generally must generate a volatility measure based on stock returns of peer public firms. To the extent that the capital structure of these peer firms is different than that of the private firm, the derived volatility measure must be adjusted to take this difference into account before it is used as an input into any option-pricing model.