A warrant is like an option - it gives the holder the right but not the obligation to buy an underlying security at a certain price, quantity and future time. It is unlike an option in that a warrant is issued by a company, whereas an option is an instrument of the stock exchange. The security represented in the warrant (usually share equity) is delivered by the issuing company instead of an investor holding the shares.
Types of Warrants
There are two different types of warrants - a call warrant and a put warrant.
• A call warrant represents a specific number of shares that can be purchased from the issuer at a specific price, on or before a certain date.
• A put warrant represents a certain amount of equity that can be sold back to the issuer at a specified price, on or before a stated date.
Features of Warrants
• A warrant certificate contains particulars regarding the underlying instrument which it represents. A warrant typically corresponds to a specific number of shares, but it can also represent a commodity, index or currency.
• All warrants have an expiry date and are classified by their exercise style. An American warrant, for instance, can be exercised anytime before or on the stated expiry date, and a European warrant, on the other hand, can be carried out only on the day of expiration.
• All warrants have a strike price which is the amount that must be paid to either buy the call warrant or sell the put warrant.
• The conversion ratio is the number of warrants needed to buy (or sell) one investment unit. Therefore, if the conversion ratio to buy stock XYZ is 3:1, this means that the holder needs three warrants in order to purchase one share. Usually, if the conversion ratio is high, the price of the share will be low, and vice versa.
Investing in Warrants
Warrants are transferable and can be listed and traded in as well. They are medium to long term investment tools. They are a high risk, high return investment schemes and attract speculators, hedgers and private investors. As the cost of a warrant is commonly low, the initial investment needed to command a large amount of equity is actually quite small. For example XYZ shares are currently priced on the market for $1.50 per share. In order to purchase 1,000 shares, an investor would need $1,500. However, if the investor opted to buy a warrant (representing one share) that was going for $0.50 per warrant, investor would be in possession of 3,000 shares using the same $1,500. This is because the prices of warrants are low and the leveraging benefit they offer is high which can be gauged by calculating the “gearing factor” that is got by dividing the original share price by the original warrant price: $1.50 / $0.50 = 3. The higher the gearing factor, the larger is the potential for capital gains (or losses).
Warrants can be risky as due to high leverage an adverse move can result in high losses. Another risk to the warrant investor is that the value of the certificate can drop to zero. If that were to happen before expiry there would not be any redemption value left. Warrants also do not confer the holder any voting, shareholding or dividend rights.Your content goes here...
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Source : PLINDIA