Chapter 10 Derivatives Flashcards
What is a warrant?
A Warrant is an option given by a company for an investor to buy shares at a specific price before a specific date.
Normally used as a Sweetener for debt offerings and preffered share issues.
3-5 years in duration
1 to 1 ratio warrants to shares.
Can be sold immediately after issuance or later.
Usually sold at a discount to share price.
What is a right?
A right gives the investor the option to buy shares based on how many shares they have already.
Used when a company wants to raise capital by issuing shares. Giving investors with share in the company an opportunity to increase their share value in proportion with the dilution of equity with share issuance.
Subscription price or offering price is the exercise price of the rights.
Rights trade at a discount
The day before the Record date is the ex-rights date.
before the ex-rights date is the cum rights period.
How does a call option work?
The holder of the option has the right to buy at a specific price, on or before a specific date. pays a premium to the writer. the holder expects the price to go up.
The writer receives a premium and expects the price to stay the same or go down.
How does covered call and naked call writing work?
Covered call writing:
Covered calls the writer owns the shares and if he is assigned must sell the shares to the holder.
If the shares go down the options expire and the writer receives the premium.
If the shares go up the writer will be assigned and must sell the shares to the option holder. They will make money on the the difference of price in buying and selling plus premium.
Naked call writing:
The writer does not own the shares. If the price of the shares goes up the writer will be assigned and have to sell the shares to the option holder at market price.
The writer will lose money if the market price is higher than the strike price plus the premium.
What’s the formula for intrinsic value ex-rights?
Market price - subscription price
Divided by
Number of rights need to buy one share
What’s the formula for the intrinsic value of rights during the cum-rights period?
Market price - subscription price
Divided by
Number of rights per share + 1
When do rights begin to trade separately from shares?
On the business day before the record date. Same as the ex-right date.
Usually they stop trading at noon of the expiration date.
