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In finance, a warrant is a security that entitles the holder to buy stock of the company
that issued it at a specified price, which is usually higher than the stock price at time of
issue.
Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the
issuer to pay lower interest rates or dividends. They can be used to enhance the yield of
the bond, and make them more attractive to potential buyers. Warrants can also be used
in private equity deals. Frequently, these warrants are detachable, and can be sold
independently of the bond or stock.
Warrants are actively traded in some financial markets such as Deutsche Börse and Hong
Kong.[1] In Hong Kong Stock Exchange, warrants accounted for 11.7% of the turnover
in the first quarter of 2009, just second to the callable bull/bear contracts.[2]
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• 11 External links
The warrant parameters, such as exercise price, are fixed shortly after the issue of the
bond. With warrants, it is important to consider the following main characteristics:
• Premium: A warrant's 'premium' represents how much extra you have to pay for
your shares when buying them through the warrant as compared to buying them
in the regular way.
• Gearing (leverage): A warrant's 'gearing' is the way to ascertain how much more
exposure you have to the underlying shares using the warrant as compared to the
exposure you would have if you buy shares through the market.
• Expiration Date: This is the date the warrant expires. If you plan on exercising the
warrant you must do so before the expiration date. The more time remaining until
expiry, the more time for the underlying security to appreciate, which, in turn,
will increase the price of the warrant (unless it depreciates). Therefore, the expiry
date is the date on which the right to exercise no longer exists.
• Restrictions on exercise: Like options, there are different exercise types
associated with warrants such as American style (holder can exercise anytime
before expiration) or European style (holder can only exercise on expiration date).
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• Warrants are considered over the counter instruments, and thus are usually only
traded by financial institutions with the capacity to settle and clear these types of
transactions.
• A warrant's lifetime is measured in years (as long as 15 years), while options are
typically measured in months. Even LEAPS (long-term equity anticipation
securities), the longest stock options available, tend to expire in two or three
years. Upon expiration, the warrants are worthless unless the price of the common
stock is greater than the exercise price.
• Warrants are not standardized like exchange-listed options. While investors can
write stock options on the ASX (or CBOE), they are not permitted to do so with
ASX-listed warrants, since only companies can issue warrants, and while each
option contract is over 1000 underlying ordinary shares (100 on CBOE), the
number of warrants that must be exercised by the holder to buy the underlying
asset depends on the conversion ratio set out in the offer documentation for the
warrant issue.
[edit] Traditional
Traditional warrants are issued in conjunction with a Bond (known as a warrant-linked
bond), and represent the right to acquire shares in the entity issuing the bond. In other
words, the writer of a traditional warrant is also the issuer of the underlying instrument.
Warrants are issued in this way as a 'sweetener' to make the bond issue more attractive,
and to reduce the interest rate that must be offered in order to sell the bond issue.
[edit] Example
Value of warrants =
[edit] Naked
Naked warrants are issued without an accompanying bond, and like traditional warrants,
are traded on the stock exchange. They are typically issued by banks and securities firms.
These are also called covered warrants, and are settled for cash, e.g. do not involve the
company who issues the shares that underly the warrant. In most markets around the
world, covered warrants are more popular than the traditional warrants described above.
Financially they are also similar to call options, but are typically bought by retail
investors, rather than investment funds or banks, who prefer the more keenly priced
options which tend to trade on a different market. Covered warrants normally trade
alongside equities, which makes them easier for retail investors to buy and sell them.
• "Traditional" warrant
• Naked warrant
• Exotic warrant
o Barrier warrant
Covered warrant
Hit-warrant
Turbo warrant
Snail warrant
• Third party warrants
[edit] Pricing
• Intrinsic value: This is simply the difference between the exercise (strike) price
and the underlying stock price. Warrants are also referred to as in-the-money or
out-of-the-money, depending on where the current asset price is in relation to the
warrant's exercise price. Thus, for instance, for call warrants, if the stock price is
below the strike price, the warrant has no intrinsic value (only time value - to be
explained shortly). If the stock price is above the strike, the warrant has intrinsic
value and is said to be in-the-money.
• Time value: Time value can be considered as the value of the continuing exposure
to the movement in the underlying security that the warrant provides. Time value
declines as the expiry of the warrant gets closer. This erosion of time value is
called time decay. It is not constant, but increases rapidly towards expiry. A
warrant's time value is affected by the following factors:
o Time to expiry: The longer the time to expiry, the greater the time value of
the warrant. This is because the price of the underlying asset has a greater
probability of moving in-the-money which makes the warrant more
valuable.
o Volatility: The more volatile the underlying instrument, the higher the
price of the warrant will be (as the warrant is more likely to end up in-the-
money).
o Dividends: To include the factor of receiving dividends depends on if the
holder of the warrant is permitted to receive dividends from the underlying
asset.
o Interest rates: An increase in interest rates will lead to more expensive call
warrants and cheaper put warrants. The level of interest rates reflects the
opportunity cost of capital.
[edit] Uses
• Portfolio protection: Put warrants allow you to protect the value of your portfolio
against falls in the market or in particular shares.
• Low cost
• Leverage
[edit] Risks
There are certain risks involved in trading warrants – including time decay. Time Decay:
'Time value' diminishes as time goes by - the rate of decay increases the closer you reach
the date of expiration.
The term warrant is sometimes used in the US to mean a check or an IOU issued by a
governmental agency. California differenciates between normal warrants, which can be
exchanged immediately for cash and registered warrants which are IOUs.[2]
In the late 1990s, when the State of California had a budget crisis due to a disagreement
between the governor and the legislature, the state treasurer was forced to issue warrants
paying 18% interest in lieu of being able to pay the state's bills with real money. The state
had not issued warrants since before the Depression of the 1930s. Many institutions
accepted them at face value because of the interest provision. Interestingly, the
comptroller of Los Angeles County was buying the warrants because the county had
surplus funds to take advantage of the higher interest rates on the warrants.
In some states, a warrant is a demand draft drawn on a government's treasury to pay its
bills. Checks or electronic payments have replaced these warrants, but in Arkansas, some
counties and school districts uses warrants for non-electronic payments