WARRANTS

&CONVERTIBLES

WARRANTSWarrants are call options that give the holder the right, but

not the obligation, to buy shares of common stock directly

from a company at a fixed price for a given period of time.

Warrants tend to have longer maturity periods than

exchange traded options.

Warrants are generally issued with privately placed bonds

as an “equity kicker”.

Warrants are also combined with new issues of common

stock and preferred stock, given to investment bankers as

compensation for underwriting services.

TYPES OF WARRANTS

When warrants are issued along with host securities and

detachable are called Detachable Warrants

In some cases warrants can be sold back to company

before the expiry date they are known as Puttable

Warrants

NAKED WARRANTS are issued separately not with host

securities

ADVANTAGES OF WARRANTS

Warrants makes the non convertible debentures and

other debentures more attractive and acceptable.

Debentures along with the warrants are able to create

their own market and reduce the company's

dependence on financial institution's.

Since the exercise of the warrants take place at future

date , the cash flow & the capital structure of company

can be planed accordingly.

The cost of debt is reduced if warrants are attached to

it. Investors are willing to accept lower interest rates

in the anticipation of enjoying the capital appreciation

of equity value at later date

Warrants provide high degree of leverage to the

investors. It can sell the warrants in the market or

convert it into stocks or allow it to lapse

Warrants are liquid they are traded in stock

exchanges

CONVERTIBLE BONDSA convertible bond is similar to a bond with warrants.

The most important difference is that a bond with

warrants can be separated into different securities and a

convertible bond cannot.

The minimum (floor) value of convertible:

Straight or “intrinsic” bond value

Conversion value

The conversion option has value.

THE VALUE OF CONVERTIBLE BONDS

The value of a convertible bond has three

components:

1. Straight bond value

2. Conversion value

3. Option value

THE VALUE OF CONVERTIBLE BONDS

Stock Price

Straight bond value

Conversion Value

= conversion ratio

floor value

floor value

Convertible bond values

Option value

CONVERSION POLICYMost convertible bonds are also callable.

When the bond is called, bondholders have about 30 days

to choose between:

1. Converting the bond to common stock at the

conversion ratios.

2. Surrendering the bond and receiving the call price in

cash.

VALUVATION OF WARRANTS Theoretical value – theoretical value can be found out if

we know the ordinary share s market price and warrants

excise price

Warrants Theoretical value =

( share price - exercise price )* exercise ratio

Y W & C are Issued ??Convertible bonds reduce agency costs, by aligning the

incentives of stockholders and bondholders.

Convertible bonds also allow young firms to delay expensive

interest costs until they can afford them.

Support for these assertions is found in the fact that firms

that issue convertible bonds are different from other firms:

The bond ratings of firms using convertibles are lower.

Convertibles tend to be used by smaller firms with high growth

rates and more financial leverage.

Convertibles are usually subordinated and unsecured.

REASONS FOR ISSUING WARRANTS AND CONVERTIBLES

A reasonable place to start is to compare a hybrid like

convertible debt to both straight debt and straight

equity.

Convertible debt carries a lower coupon rate than does

otherwise-identical straight debt.

Since convertible debt is originally issued with an out-

of-the-money call option, one can argue that convertible

debt allows the firm to sell equity at a higher price than

is available at the time of issuance.

Cont..

From the shareholder’s perspective, the optimal call

policy is to call the bond when its value is equal to the

call price.

In the real world, most firms wait to call until the

bond value is substantially above the call price.

Perhaps the firm is afraid of the risk of a sharp drop in

stock prices during the 30-day window. \

SUMMARY & CONCLUSIONSConvertible bonds and warrants are like call options.

However, there are important differences:

Warrants are issued by the firm.

Warrants and convertible bonds have different effects on corporate

cash flow and capital structure.

Warrants and convertibles cause dilution to existing shareholder’s

claims.

Many arguments, both plausible and implausible, are given for issuing

convertible securities.

Convertible bonds lends the chance to benefit from risks and reduces

the conflicts between bondholders and stockholders concerning risk.

By Shashi kumar M RMBA1NZ12MBA51NEW HORIZON COLLEGE OF MANAGEMENT STUDIES