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Unformatted text preview: Chapter 25: Warrants and Convertibles 25.1 a. A warrant 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. b. A convertible bond 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. 25.3 a. 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. b. 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 dilution . 25.4 a. 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 worth $1,750 (= $3,500 / 2 shares). b. When the warrant was issued, the firm received $500 from Tina, increasing the total value of the firm’s assets to $4,000 (= $3,500 + $500). If the two shares of common stock were the only outstanding claims on the firm’s assets, each share would be worth $2,000 (= $4,000 / 2 shares). However, since the warrant gives Tina a claim on the firm’s assets worth $500, the value of the firm’s assets available to stockholders is only $3,500 (= $4,000 - $500). Since there are two shares outstanding, Survivor’s value per share remains at $1,750 (= $3,500 / 2 shares) after the warrant issue. Note that the firm uses Tina’s $500 to purchase one more ounce of platinum. c. If the price of platinum is $520 per ounce, the total value of the firm’s assets is $4,160 (= 8 oz of platinum * $520 per oz). If Tina does not exercise her warrant, the value of the firm’s assets would remain at $4,160 and there would be two shares of common stock outstanding....
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- Fall '08
- Convertible bond