Definition
A Warrant (WT) is a derivative security that gives the holder the right, but not the obligation, to buy a company’s stock at a specific price, called the exercise or strike price, within a certain period, typically before the warrant’s expiration. Warrants are often issued by companies as a means of raising capital and can be attached to bonds or preferred stock as an added incentive for purchase.
Key Characteristics of Warrants:
- Exercise Price: The set price at which the warrant holder can purchase the underlying stock.
- Expiration Date: The date by which the warrant must be used, otherwise it becomes worthless.
- Type: Warrants can be either call warrants or put warrants, depending on whether they grant the right to buy (call) or sell (put) the stock.
Examples
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Company ABC Issues Warrants:
- Company ABC issues a warrant giving the holder the right to purchase shares at $50 per share anytime between now and five years from the issue date. If the share price rises to $70, the holder can exercise the warrant to buy shares at a discount.
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Warrants Attached to Bonds:
- A tech startup issues bonds with detachable warrants that can be exercised to buy common stock at a future date. Investors might be more inclined to buy these bonds because the attached warrants offer potential upside in the company’s stock.
Frequently Asked Questions (FAQs)
What happens when a warrant expires?
When a warrant expires, it becomes worthless if not exercised before the expiration date. The holder loses the right to purchase the company’s stock at the earlier set price.
How does a warrant differ from an option?
While both warrants and options grant rights to buy (or sell) stocks at a set price, warrants are issued by the company itself, often with longer durations, whereas options are typically standardized instruments traded on exchanges.
What is a Subscription Right?
A Subscription Right is similar to a warrant, allowing existing shareholders the right to purchase additional shares of stock, often at a discount, before the stock is offered to the public.
Are warrants safe investments?
Warrants are riskier than regular stocks because their value is highly dependent on the price movement of the underlying stock. They can offer high returns but also come with the risk of expiring worthless.
Can warrants be traded independently of the associated bonds or preferred stocks?
Yes, many warrants are detachable, meaning they can be sold or traded independently of the bonds or preferred shares they were originally issued with.
Related Terms with Definitions
- Subscription Right: The privilege granted to existing shareholders to buy additional shares in a new stock issuance, often at a discount.
- Derivative Security: A financial instrument whose value depends on the value of an underlying asset, typically instruments like options or warrants.
- Strike Price: The set price at which a warrant or option can be exercised to purchase or sell the underlying asset.
- Expiration Date: The date on which a warrant or option becomes void if it is not exercised.
Online References
- Investopedia - Warrants
- Wikipedia - Warrants (finance)
- Securities and Exchange Commission (SEC) - Warrants
Suggested Books for Further Studies
- “Options, Futures, and Other Derivatives” by John C. Hull - A comprehensive guide covering various derivative instruments including warrants.
- “The Complete Guide to Option Pricing Formulas” by Espen Gaarder Haug - Detailed explanations and formulas related to option and warrant pricing.
- “Options as a Strategic Investment” by Lawrence G. McMillan - Highly regarded book that includes a section on warrants and their strategic uses.
Fundamentals of Warrants (WT): Investment Basics Quiz
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