LA 4 - Warrants

Question 1

What is a warrant?

Answer 1

Fin.Instrument
that will pay out CASH (or underlying)
at specified date in future
if underlying on which it is based is
- above (calls)
- below (puts)
a predetermined price (strike/exercise price)

Question 2

Why would an investor choose warrants over options (and other derivatives)?

Answer 2

Warrants tend to be less risky i.e. if his appetite is not suited to options but still wishes risky investments

Question 3

Why would a company issue warrants?

Answer 3

Can be used for capital financing
esp. in case of share issue limits, a co. can issue warrants to source additional capital and thereby bypass the restrictions

Question 4

What is the three main differences between warrants and options?

Answer 4

Warrants are traded on the equity market
Options are trade on the derivatives market

Warrants listed by ISSUERS on JSE
Options listed by JSE

Warrants: volatility levels allocated by Issuer
Options: volatility levels allocated by JSE

Question 5

What is meant by leverage/gearing?

Answer 5

Use of a fin.instrument to gain greater exposure to potential return on an investment whilst investing a smaller amount

NOTE: Converse is also true

Question 6

What is meant by the cover ratio?

Answer 6

warrants needed to gain exposure to one security

Question 7

What are the advantages of warrants i.t.o. profit and cost?

Answer 7

Unlimited upside but limited down –> max loss is premium paid

Transaction costs low

Question 8

What are the advantages of warrants i.t.o. strategy?

Answer 8

Can be used for:

• gearing
• taking advantage of different market conditions

Question 9

What are the risks of warrants i.t.o. loss and potential loss?

Answer 9

Credit risk

Price risk

Question 10

What are the risks of warrants i.t.o. time?

Answer 10

Limited life span
- warrant may expire before holder’s expectations realised
Effect of time decay
- time value is zero at maturity date
Effect of extraordinary events
- issuer has right to declare an extraordinary event resulting in premature expiry

Question 11

How are warrant’s prices effected by the underlying (stock) price?

Answer 11

Calls: direct relationship….S0 increase -> c/C increase
Puts: inverse relationship…S0 increase -> p/P decrease

Question 12

How are warrant’s prices effected by the strike/exercise price?

Answer 12

Calls: inverse relationship…K increase -> c/C decrease
Puts: direct relationship…K increase -> p/P increase

Question 13

How are warrant’s prices effected by the time-to-expiration?

Answer 13

European calls and puts: RELATIONSHIP UNCERTAIN
Am.Calls: direct relationship…T increase -> c/C increase
Am.Puts: direct relationship…T increase -> p/P increase

Question 14

How are warrant’s prices effected by the volatility?

Answer 14

Calls: direct relationship…Theta increase -> c/C increase
Puts: direct relationship…Theta increase -> p/P increase

Question 15

How are warrant’s prices effected by the risk-free-rate?

Answer 15

Calls: direct relationship….r increase -> c/C increase
Puts: inverse relationship…r increase -> p/P decrease

Question 16

How are warrant’s prices effected by the dividends?

Answer 16

Calls: inverse relationship…D increase -> c/C decrease
Puts: direct relationship…D increase -> p/P increase

Question 17

What is a Vanilla warrant?

Answer 17

Also called Single equity warrant
issued on single security
settlement in cash or by delivery of underlying security

Question 18

What is an Index warrant?

Answer 18

Warrant issued on particular index

settlement by cash

Question 19

What is a Basket warrant?

Answer 19

Basket of securities (generally in a specific industry)

settlement by cash or delivery of underlying securities

Question 20

What is a Barrier warrant?

Answer 20

Single equity warrant that have a barrier level into which the underlying is confined.
If barrier is breached then the warrant expires worthless

Question 21

What is a Turbo warrant?

Answer 21

A barrier option in which the barrier lies in the in-the-money side of the strike price

Question 22

What is a Bond warrant?

Answer 22

Vanilla warrant except the underlying is a bond, not a share

Question 23

What is a Capital Protection warrant?

Answer 23

Give the holder a guaranteed return.

in essence a combination of warrants and a RFR investment

Question 24

Reset warrant

Answer 24

Have pre-determined RESET DATE on which STRIKE PRICE can be CHANGED,
potentially in investor’s favour