Warrant (finance)

In finance, a warrant is a security that entitles the holder to buy or sell stock, typically the stock of the issuing company, at a fixed price called the strike price.

Warrants and options are similar in that the two contractual financial instruments allow the holder special rights to buy securities. Both are discretionary, and have expiration dates. They differ mainly in that warrants are only issued by specific authorized institutions (typically the corporation on which the warrant is based), and in certain technical aspects of their trading and exercise.

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 bonds 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.

In the case of warrants issued with preferred stock, stockholders may need to detach and sell the warrant before they can receive dividend payments. Thus, it is sometimes beneficial to detach and sell a warrant as soon as possible so that the investor can earn dividends.

Warrants are actively traded in some financial markets, such as the German and Hong Kong stock exchanges.[1]

Structure and features

Warrants have similar characteristics to that of other equity derivatives, such as options, for instance:

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:

• Exercising: A warrant is exercised when the holder informs the issuer their intention to purchase the shares underlying the warrant.

• 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 ceases to exist.
• 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).

Secondary market

Sometimes the issuer will try to establish a market for the warrant and to register it with a listed exchange. In this case, the price can be obtained from a stockbroker. But often, warrants are privately held or not registered, which makes their prices less obvious. On the NYSE, warrants can be easily tracked by adding a "w" after the company's ticker symbol to check the warrant's price. Unregistered warrant transactions can still be facilitated between accredited parties and in fact, several secondary markets have been formed to provide liquidity for these investments.

Comparison with call options

Warrants are very similar to call options. For instance, many warrants confer the same rights as equity options and warrants often can be traded in secondary markets like options. However, there also are several key differences between warrants and equity options:

• Warrants are issued by private parties, typically the corporation on which a warrant is based, rather than a public options exchange.
• Warrants issued by the company itself are dilutive. When the warrant issued by the company is exercised, the company issues new shares of stock, so the number of outstanding shares increases. When a call option is exercised, the owner of the call option receives an existing share from an assigned call writer (except in the case of employee stock options, where new shares are created and issued by the company upon exercise). Unlike common stock shares outstanding, warrants do not have voting rights.
• Unlisted 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. Other warrants are traded on exchanges.
• Often, 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

Types of warrants

The reasons you might invest in one type of warrant may be different from the reasons you might invest in another type of warrant. A wide range of warrants and warrant types are available:

• Equity warrants: Equity warrants can be call and put warrants. Callable warrants offer investors the right to buy shares of a company from that company at a specific price at a future date prior to expiration. Puttable warrants offer investors the right to sell shares of a company back to that company at a specific price at a future date prior to expiration.
• Covered warrants: A covered warrant is a warrant that has some underlying backing, for example the issuer will purchase the stock beforehand or will use other instruments to cover the option.
• Basket warrants: As with a regular equity index, warrants can be classified at, for example, an industry level. Thus, it mirrors the performance of the industry.
• Index warrants: Index warrants use an index as the underlying asset. Your risk is dispersed—using index call and index put warrants—just like with regular equity indexes. They are priced using index points. That is, you deal with cash, not directly with shares.
• Wedding warrants: are attached to the host debentures and can be exercised only if the host debentures are surrendered
• Detachable warrants: the warrant portion of the security can be detached from the debenture and traded separately.
• Naked warrants: are issued without an accompanying bond and, like traditional warrants, are traded on the stock exchange.

See also

• Contract for difference
• Dilutive security

Sources

• Incademy
• Investopedia
• Invest-FAQ
• Basics of Financial Management, 3rd ed. Frank Bacon, Tai S. Shin, Suk H. Kim, Ramesh Garg. Copley Publishing Company. Action, Mass., 2004.
• Special Situation Investing: Hedging, Arbitrage, and Liquidation, Brian J. Stark, Dow-Jones Publishers. New York, NY, 1983. ISBN 0-87094-384-7; ISBN 978-0-87094-384-3.

External links

• Canadian Stock Warrants
• Common Stock Warrants