Answers to End-of-Chapter Problems
Chapter 25: Warrants and Convertibles
is a security that gives its 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.
warrant specifies the number of shares of stock that the holder can buy, the exercise price,
and the expiration date.
is a bond that may be converted into another form of security, typically
common stock, at the option of the holder at a specified price for a specified period of time.
If the stock price is less than the exercise price of the warrant at expiration, the warrant is
Prior to expiration, however, the warrant will have value as long as there is some
probability that the stock price will rise above the exercise price in the time remaining until
expiration. Therefore, if the stock price is below the exercise price of the warrant, the lower
bound on the price of the warrant is zero.
If the stock price is above the exercise price of the warrant, the warrant must be worth at least
the difference between these two prices.
If warrants were selling for less than the difference
between the current stock price and the exercise price, an investor could earn an arbitrage
profit (i.e. an immediate cash inflow) by purchasing warrants, exercising them immediately,
and selling the stock.
If the warrant is selling for more than the stock, it would be cheaper to purchase the stock
than to purchase the warrant, which gives its owner the right to buy the stock.
upper bound on the price of any warrant is the firm’s current stock price.
The primary difference between warrants and call options is that, when warrants are
exercised, the firm issues new shares.
Both the purchase price and the exercise price of a
warrant are received by the firm and increase the value of its assets.
Unless a firm is selling
calls on its own shares, this does not hold true for options.
When call options are exercised, the number of shares the firm has outstanding remains
unchanged. Shares of the company’s stock are simply transferred from one individual to
another. When warrants are exercised, however, the number of shares outstanding increases.
This results in the value of the firm being spread out over a larger number of shares, often
leading to a decrease in value of each individual share. The decrease in the per-share price of
a company’s stock due to a greater number of shares outstanding is known as
Before the warrant was issued, Survivor’s assets were worth $3,500 (= 7 oz of platinum *
$500 per oz).
Since there are only two shares of common stock outstanding, each share is
(= $3,500 / 2 shares).