Warrant is the security, which gives holder the right, but not obligation, to purchase firm's common stock directly from a firm at a specified price for a given period of time. Warrant is characterized by the number of shares of stock that the holder can buy, the exercise price, and the expiration date.
Purpose of using warrant
Warrant are often treated as equity kickers, because they are usually issued together with privately issued bonds. The loan agreement states, when warrants can be detached from the bonds, usually it is possible immediately. The purchase price for the stock connected to the warrant is typically higher than the share's price, at the time the company issues the bond but is also lover than the expected future stock price. The warrant makes the debenture (issued bond) more desirable, which lowers its required yield. The warrant also provides the company with future common stock capital when the holder exercises the warrant and buys the stock from the firm.
Differences between warrants and call options
From the holder point of view, that warrant is similar financial instrument to the call option, and the main difference is maturity period (warrants usually have longer maturity options than call options, some of them are even perpetual). From the company point of view, warrants are totally different from call options.
Call options are issued by individuals while warrants are issued by firms and when a warrant is exercised, a firm must issue new shares of stock, what causes the increase in number of outstanding shares. On the other hand, when the call option is exercised, there is no increase in number of outstanding company shares.
- Ayres, H. F. (1963). Risk aversion in the warrant markets. IMR; Industrial Management Review (pre-1986), 5(1), 45.
- Hillier, D. J., Ross, S. A., Westerfield, R. W., Jaffe, J., & Jordan, B. D. (2010). Corporate finance (No. 1st Eu). McGraw-Hill.
- Reilly, F., & Brown, K. (2011). Investment analysis and portfolio management. Cengage Learning., Harcourt College Pub 2002, page 82, 85
Author: Mateusz Bąk