Warrants Flashcards
What is a company warrant
Equity warrant
A security that entitles holder the right (without obligation) to buy new ord shares in the issuing co @ fixed future date & price
Similar to call options
Derivative instruments (price of underlying share - calculated by Co and advisors)
Traded on recognises stock exchanges/ stand alone products prices available from brokers & SE
When exercised raise additional capital/ finance for co (known capital income @ future date)
Form of share dilution in value of existing shares falls as more in issue (if shareholders wish to maintain position must subscribe for new)
Outline company warrant terminology
Warrant price - amount paid by holder to acquire right to purchase shares @ stated price and fixed date (set by Co)
-some warrants issued as sweeteners (nil paid) given away to encourage purchase
Exercise price - amount warrant holder will pay to purchase new shares when exercising warrant
Underlying share price - current share price for ord share which is brought/ traded in market
Intrinsic value - difference in market price and exercise price (investors want huger market price - buy for less to make profit)
Time value = warrant price - intrinsic value (reflects amount wiling to pay for share)
Warrant premium = warrant price + exercise price - underlying share price
(Amount holder will gain if they exercise warrant)
Gearing = performance of warrant/ leveraged/ % terms how greater warrant value is over share price
Warrant price mirror underlying share but price movement of warrant exceeds that of share
Outline characteristics of company warrants
Instruments of bull markets (investor buy cheaper & sell at higher piece to make profit)
High risk (potential total loss or considerable gains) - risk loosing warrant price than purchasing underlying asset full cost in market
No income tax implications (suitable for high rate taxpayer)
Potential for CGT when selling
Long dates; right to purchase shares at future date which could be years
Greater risks than ord shares/ no risk of sweetners
Traded on recognised stock exchanges
FCA states holders must sign warrant risk notice form prior to confirm understanding of risks and product
Wasting assets
Pricing and value of company warrants
Pricing of warrant must be lower than price of equity in market (discount)
Warrants become worthless if it’s obvious there’s little likelihood of price rise in share & exercise price is greater than market price
Advantages of company warrants
Traded independently from share
Inexpensive to issue
Raise additional capital for Co
Initial outlay only fraction of cost of underlying ord share
Disadvantages of company warrants
Purchasers no voting rights/ control until warrants converted Into shares
Produce no income/ not entitled to dividend therefore market is illiquid
If not exercised warrants expire & worthless
What are Covered warrants
Securitised derivative products
Provide holder with right (without obligation) to buy or sell and underlying asset to issuer through broker @ fixed price and date
Covered because issuers either hold or buy underlying asset in market then offer warrant
Issuer is not entity who’s shares are issues (investment bank or 3rd party)
Holder of the warrant is investor
Price paid for right is premium
Users - individuals and institutional
Leveraged/ geared = high returns
Max loss known limited to original investment
Types of covered warrants
Call covered;
Give holder right to purchase underlying share @ agreed fixed price
- covered warrant premium is price paid for right
- holder wishes to buy asset below MP and sell for more = profit (bull market)
Put covered;
Gives holder right to sell underlying share @ agreed fixed price
- premium price paid
- holder expects price of asset to fall, sell at strike price and buy back lower price (bearer market)
Investor decides to buy call or put covered warrants depending on how anticipate price will move
What are the exercise styles of warrants
American style;
Allows holder to exercise at any time up to expiry date
European style;
Allows holder to exercise only in expiry date
What does the term sheet cover
Name of investor
Details of security
Strike price
Expiry date
Type (call or put)
Exercise style
How are covered warrants settled
Cash settled
T+3 days
Electronic (CREST)
Purchase of warrant via stockbroker rather than co who’s shares warrant is based/ purchase and stockbroker already hold relationship and trading account (must indicate intention to trade particular warrant)
Legal obligation for issuer to make or take delivery of shares during warrant
Terms in T;Cs
Purchaser must agree to disclaimer and indicate understanding if product and inherent risks involved in a suitability questionnaire
What choices do warrant holders have
1) exercise option @ strike price (buy or sell security)
2) abandon/ walk away if not profitable on or before expiry
3) tradeback/ issuer buy back through stockbroker (fully tradeable)
Outline additional features of covered warrants
Regulated market trading
No stamp duty / possible CGT
underlying term sheet
when assessing profit/ losses investors must consider commissions and transaction costs
Contract - legally binding
No margin calls
Wasting assets
Investors must be aware there’s different competing warrants for same shares from different issuers
Income flows; payment for warrant itself & potential cash settlement by issuer
Advantages of covered warrants
Initial outlay small
No stamp duty bc cash settled
Holders have ability to hedge position in rising or falling markets
Investors don’t need to monitor daily as exercise if automatic
No margin calls
FCA regulated exchange
Disadvantages
Cannot be sold short (borrow shares, sell, buy back for less, pocket difference and give back to lenders)
Worthless after expiry date
Cannot be brought or held in savings accounts (ISA)
High risk investments
