Nicholas Waltner's  Instablog

Morgan Stanley ("MS") agreed this morning to repurchase its TARP warrants from the US Treasury for $950 million. This compares favorably to the Congressional Oversight Panel's estimate of $870 million. Assuming a 2% dividend yield (MS is 2.12% currently), I estimate that MS paid a 39% volatility, which is roughly a 5-7 volatility point discount relative to the January 2011 $22.5 strike listed call options, which is quite fair given the enormous size of the warrant on 65mm shares and 9.3 year maturity. Hence, I would argue that this price was very a "fair one" relative to what a disinterested third-party buyer would have paid.

Although some have argued that the warrants were worth as much as $1.2 billion that would imply a 58% volatility, which with VIX now trading in the mid 20's no equity derivatives dealer in his/her right mind would ever pay.

Finally, for all of those demanding an auction of the warrants, why aren't the hedge funds clamoring to buy these instruments? The answer is that they are huge, difficult to hedge precisely and are receiving relatively high prices from their issuers.


Disclosure: No positions.

S&P/Case-Shiller posted its monthly update on the US residential real estate market this AM. While its 20 City Index still posted a -17.06% decline, 14 of the 20 cities posted month-over-month increases, which has not happened since mid-2006. While the Seattle market witnessed a slight decline of 0.28%, prices have now been stable since March in this market. The only markets showing continued weakness are the speculative ones of Miami, Phoenix and Las Vegas. Inventories are still troubling but clearly the downside momentum in housing prices has abated for the meantime.

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Goldman Sachs paid $1.1 billion for its 12,205,045 TARP warrants today. This amount equates to a 43.9% volatility assuming a 1.0% dividend yield. This comes at a 18% premium to the COP report and a 5% premium when adjusting for time and share price.

For purposes of comparison, the GS 125 call option expiring on July 21, 2011 was trading at $49.5 today, which equates to 43.3% implied volatility, using a 1.2% dividend yield. 

I find it quite amazing that GS paid more-or-less the same volatility for its listed options as for $1.5 billion of warrants due in 2018. I would have paid no more than a 37% volatility for a position like this one, which would translate into a price of $1.03 billion. Thus, in my view GS seems to have "paid-up" by 6.8% to get the US Government out of its affairs. 

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