Simple Analysis is Never a Solution in Valuing Complex Derivative Securities

Abstract

The valuation of complex derivative securities (options, warrants, and conversion elements with a variety of features) within these companies has evolved from a niche academic pursuit into a widespread practice and is often required for tax, financial accounting, reporting fair values, or for management purposes. Sadly, many valuation analysts resort to simplified or “canned” models and assumptions that are inappropriate for valuing contemporary derivative securities: employing inappropriate volatility assumptions; using inappropriate models or formulas; and/or ignoring the interactions between the values of various outstanding securities and dilutive securities within a company’s capital structure as the value of the company changes over time. Three important considerations demand the use of more sophisticated valuation modeling: unknown potential corporate volatility, leverage & related default risk, and multiple securities within a single corporate entity.