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REVOLUTION. JANUARY 30, 2004

TEACHING NOTE

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Arley Merchandise Corporation

Objectives and Synopsis

The Arley Items Corporation signifies an example of a company issuer looking to realize additional money00 for its prevalent shares by offering potential traders a " money-back guarantee. ” In this instance, the guarantee takes the form of the European put option (called a " Right” in the case) which can be exercisable two years from the date of concern. In some ways, the truth represents one of the design of securities to defeat information asymmetries in the capital markets. Arley's management provides projected a highly confident picture to the underwriters that the provider's future profit performance will be sufficient to propel the stock value above $8. 00 every share in two years. The investing open public (as displayed by the underwriters) is less self-confident that this effect will happen. Arley's management can demonstrate its confidence in its future forecasts by providing the " money-back guarantee. ”

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The truth offers an introduction to security design and style and choice pricing within a simple context that has instant practical relevance for the financial official of a making firm. It gives opportunities to discuss: the pricing of contingent contracts with default risk; the financial equivalence of numerous security buildings; imbedded options for shareholders and companies; and the design of securities to overcome uneven information and incentive complications.

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Recommended Assignment Inquiries

Assuming Arley's common stock would sell at $6. 50 every share inside the public market, is the suggested " money-back guarantee” likely to have enough value to bridge the $1. 55 gap known in the case? (Note: In October, 1984, the two-year Treasury strip charge was about 11% per annum. The purchase price volatility of publicly-traded prevalent stocks a lot like Arley was estimated in a standard change of 40% per annum. )

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So why was the alternate of meeting the money-back guarantee by providing a ten-year note as part of the proposal? How exactly does this affect the value with the guarantee to purchasers?

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________________________________________________________________________________________________________________ This note was made by Professors Bill E. Fruhan and AndrГ© F. Perold for the sole purpose of assisting classroom instructors in the usage of Arley Products Corporation, HBS No . 287-063. It provides analysis and concerns that are designed to present alternate approaches to deepening students' comprehension of organization issues and energizing class discussion. HBS cases will be developed exclusively as the basis for discussion in the classroom. Cases are not intended to function as endorsements, types of primary data, or illustrations of powerful or ineffective management.

Copyright © mil novecentos e noventa e seis President and Fellows of Harvard College or university. To buy copies or perhaps request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Submitting, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No component to this distribution may be reproduced, stored in a retrieval program, used in a spreadsheet, or transmitted in any form or perhaps by virtually any means—electronic, mechanised, photocopying, recording, or otherwise—without the permission of Harvard Business University.

This doc is official for use only by RICHARD SPURGIN right up until April 2013. Copying or posting can be an intrusion of copyright laws. [email protected] harvard. edu or 617. 783. 7860.

Instructing Note—Arley Goods Corporation

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How does the proposed Arley security differ from a descapotable subordinated debenture?

Teaching Plan

This teaching plan organizes the class as follows:

Valuation of the Arley " right”

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Why range from the ten-year notice alternative?

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American- vs . European-style work out?

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Commonalities to a collapsible subordinated debenture

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The option made plus the...


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