Warrants and Convertibles

 An option based financial instrument.
 Attached to bond or a preferred stock.

 It is an option to purchase a specified number of shares
of common stock at a stated price and time.
 Generally used as sweeteners in bond/ preferred stock
so that the company can easily sell all the securities at
low cost.
 Warrant holders have option to surrender/exercise the
warrants and purchase additional shares.
 After exercise of warrants, total number of shares
outstanding increases, this causes dilution in EPS.
 Bond with warrants attached is a hybrid security.
 Exercise Price: Price at which the warrant holders
can purchase a specified number of shares
 Exercise Ratio: Number of shares that can be
purchased per warrant.
 Expiration Date: The time period within which
warrants can be used for stock purchase.
 Types :
• Detachable/Negotiable
• Non-detachable/ Non-negotiable
 Warrants are about to expire and the market
price of the stock is above the exercise price.
 If the company announces dividend on the
common stock by significant amount.
 Exercise price is to be increased in case of
warrants with stepped-up exercise price
provision.
 Warrants can be provided for additional equity
funds in future.
 Used by growing firms as sweeteners (make
the issue attractive) to reduce cost of capital.
 To reduce floatation cost.
 Reduces agency conflict between debt holders
and equity holders.
 The market value of warrants is generally
above the theoretical value of warrant.
 Leverage effect of warrant.
 Arbitrage opportunity exists if it is below the
theoretical value.
 It comes closer to the theoretical value as
expiration date approaches.
 Warrant premium
 Amazon Inc. stocks are currently trading at $100 at the NYSE.
The company has detachable warrants outstanding which are
currently priced at $10 per warrant. The warrants have
remaining expiration period of 2 years and each warrant
entitles the holder to purchase 1 share of the company at
exercise price of $100.
 You have $100 to invest. You can either invest in the stock of
the company or purchase warrants.
 Calculate your return if the stock price of Amazon increases to
$120 after 2 year.
 EPS Reporting
• Primary EPS
• Fully Diluted EPS
 Convertible securities are bonds or preferred stock
that can be exchanged for stated number of common
stock at the option of the holder within stipulated
period of time
 Increases marketability of the security.
 A hybrid security
 It promises a fixed income associated with bonds as
well as chance of capital gains associated with
equity share after the owner exercises his conversion
option.
 Sweetener
 Conversion Ratio: The number of shares of
common stock for which convertible may be
exchanged.
 Conversion Price: The price paid for the
ordinary share at the time of conversion.
 Conversion Value: The conversion value of the
bond is the value of the stock received upon
conversion.
• Original Conversion Value
• Conversion Value at Time t
 Straight Debt Value: The value of the bond without
conversion feature.
 Conversion Premium
• Initial Conversion Premium
• Conversion Premium in Subsequent Year (The
premium results because the convertible offers fixed
income at a low risk of price decline while assuring
the chances of capital gains when the share price
increases)
 Market Value of Convertible
 Minimum Value of Convertible/Floor Value of
Convertible
 Call Policy on Convertible Bond
 Sweetening fixed-income securities
 Deferred equity financing: Selling ordinary
shares in future in a higher price.
 Avoiding earnings dilution.
 Raising low cost capital.
 Reduce Agency Cost
 Avoid negative signaling effect of issuing
stock directly.
1 Warrants are usually detachable and 1 Conversion option attached to a
sold separately. bond/preferred stock are not
detachable.
2 Exercise of warrants increases total 2 Total capital remains constant after
amount of capital. conversion.
3 Generally used privately. 3 They are usually issued publicly.
4 Company receives additional funds 4 No additional funds are received at

when warrants are exercised. conversion of convertible.
5 Warrants are not callable. 5 Convertibles can be called.
6 Bonds and preferred stock remain on the 6 The fixed-income securities are
company’s books after the exercise of exchanged for common stock and taken
warrants. off the company’s books.
7 Warrants are exercised under warrant 8 Because of the call feature, convertibles
holders’ option as a result firms do not give the firm greater control over the
have control over the timing of the timing of capital structure.
capital structure.
 Both are issued to attract investors.
 Reduces cost of capital for the firm.
 Both contain call option (investors receive option to gain
common shares at the exercise price or conversion price
even if the market value is much higher).
 Investors get the chance to receive fixed-income (from bond
or preferred stock) as well to benefit from capital gains due
to increase in share price.
 Both convertibles and warrants tend to lessen potential
conflict between fixed income security holders and
stockholders, thereby reducing agency costs.
 Both allow for deferred issuance of common stock at a price
higher than the prevailing market price.

Warrants and Convertibles

Uploaded by

Copyright:

Available Formats

Warrants and Convertibles

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Warrants and Convertibles

Uploaded by

Copyright:

Available Formats

 An option based financial instrument.

 Attached to bond or a preferred stock.

4 Company receives additional funds 4 No additional funds are received at

You might also like