still:

i would like the treasury to explain this publicly and not us.

In other words, Wilson’s (et al) objections seem like much ado about nothing.

strike the third sentence of my second paragraph.

in any case a private buyer would not pay theory value for it — private buyers would want to be compensated for the risk (taking borrow rate into account is a decent proxy for this).

what i am thinking is that $1.2M is a low but feasible price for these options.

i have no idea though why the treasury saw fit to sell them and not hold to maturity.

i think that 35% vol is very high for a 10 year option. but there is no market for this so who knows. right now the market would price in a very high cost of capital (which would show up as high vol, if you fix the risk free rate) and the treasury could but probably wouldn’t.

at 25% vol the price is $2.05, which is still higher than the treasury number, but within the debatable level of difference.

likelihood of cancellation and dilution are not really modelable.

Let’s just price it up following the div-adjusted model (page 15 model) with the following inputs and see what we get:

Vol – I agree with q that the low-end vol is nearest to where the market would price these warrants. 35% seems reasonable to me.

DivYld – I think the high-end div assumption is too low for a long-term div yield. The mid-level div yield (which corresponds to average historic div yield) seems ok to me. 3.93%.

Likelihood of Cancellation – Wilson’s model assumes that the probability that the company will execute a qualifying equity issuance in 2009 (thus canceling half the warrants) is independent of the stock price. This is probably a poor assumption. But I don’t feel like building a simulation (not to mention making an uninformed correlation assumption), so I’ll roll with this one. Let’s just go with the mid-level assumption that there’s a 30% chance that half the warrants will disappear (deflating the expected number of warrants by 15%).

Risk-free rate: 3.19%.

This gives us $3.28 per option, which is twice what Treasury received.

there are other problems with the paper. why is he not using the 10Y treasury as the risk free rate, as opposed to a short dated LIBOR? also, how can he consider the low dividend assumption at all, given that this represents a situation where the bank remains distressed in which case the stock will remain low and the warrants will be worth very little?

one beef. i would guess his volatility estimates are too high, even in the low case.

the volatility seems to be pretty high — the low volatility estimate of 37% suggests that this is a volatile stock.

the high volatility estimate — 80+% is sheer nonsense. no stock in the world is going to have 80% volatility for ten years.

the methodology for choosing the middle volatility is not correct. he is using volatility from a very short dated option to price a ten year option. the observed (ie implied) volatility of a long dated option is generally much lower than the volatility of a short dated option.

in reality though there are very very few ten year options in the marketplace, and nobody would know for sure the price through a formula. instruments like these often trade at large discounts to the model. the only way to find out is, like nemo suggested, to sell some of them and see what bids you get.

The Treasury and FED should start charging fees to all the participants in their various programs to make up for the money the Treasury has lost. Another way to recoup the losses is to charge a transaction fee on all stock, commodity, and derivative trades. Imagine how much a 2% fee would bring into the Treasury.

There is no reason for the taxpayers to get stuck with the bill for these bailouts.