Chapter 24: 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.
Each 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 worthless.
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
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.
Therefore, an 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
Since there are only two shares of common stock outstanding, each share is worth
$3,500 / 2 shares).