Appraisal Economics Inc. has determined the value of the “embedded derivative” in convertible preferred securities issued by the operating partnership of a large publicly traded real estate investment trust (REIT). The preferred securities receive quarterly dividend payments and also contain an embedded derivative to convert into shares of the publicly traded REIT’s common stock, which is effectively a call option. We determined the fair value of the embedded derivative using binomial models and a “with and without” valuation method. We used a binomial model to determine the fair value of the aggregate preferred security and a second binomial model to determine the value of the preferred assuming that it was not convertible into common stock. The value of the embedded derivative is the difference in value indicated by the two models.
Please click for more information about the valuation of complex securities.