 An option based financial instrument.

 Attached to bond or a preferred stock.

 It is an option to purchase a specified number of shares
of common stock at a stated price and time.
 Generally used as sweeteners in bond/ preferred stock
so that the company can easily sell all the securities at
low cost.
 Warrant holders have option to surrender/exercise the
warrants and purchase additional shares.
 After exercise of warrants, total number of shares
outstanding increases, this causes dilution in EPS.
 Bond with warrants attached is a hybrid security.
 Exercise Price: Price at which the warrant holders
can purchase a specified number of shares
 Exercise Ratio: Number of shares that can be
purchased per warrant.
 Expiration Date: The time period within which
warrants can be used for stock purchase.
 Types :
• Detachable/Negotiable
• Non-detachable/ Non-negotiable
 Warrants are about to expire and the market
price of the stock is above the exercise price.
 If the company announces dividend on the
common stock by significant amount.
 Exercise price is to be increased in case of
warrants with stepped-up exercise price
provision.
 Warrants can be provided for additional equity
funds in future.
 Used by growing firms as sweeteners (make
the issue attractive) to reduce cost of capital.
 To reduce floatation cost.
 Reduces agency conflict between debt holders
and equity holders.
 The market value of warrants is generally
above the theoretical value of warrant.
 Leverage effect of warrant.
 Arbitrage opportunity exists if it is below the
theoretical value.
 It comes closer to the theoretical value as
expiration date approaches.
 Warrant premium
 Amazon Inc. stocks are currently trading at $100 at the NYSE.
The company has detachable warrants outstanding which are
currently priced at $10 per warrant. The warrants have
remaining expiration period of 2 years and each warrant
entitles the holder to purchase 1 share of the company at
exercise price of $100.
 You have $100 to invest. You can either invest in the stock of
the company or purchase warrants.
 Calculate your return if the stock price of Amazon increases to
$120 after 2 year.
 EPS Reporting
• Primary EPS
• Fully Diluted EPS
 Convertible securities are bonds or preferred stock
that can be exchanged for stated number of common
stock at the option of the holder within stipulated
period of time
 Increases marketability of the security.
 A hybrid security
 It promises a fixed income associated with bonds as
well as chance of capital gains associated with
equity share after the owner exercises his conversion
option.
 Sweetener
 Conversion Ratio: The number of shares of
common stock for which convertible may be
exchanged.
 Conversion Price: The price paid for the
ordinary share at the time of conversion.
 Conversion Value: The conversion value of the
bond is the value of the stock received upon
conversion.
• Original Conversion Value
• Conversion Value at Time t
 Straight Debt Value: The value of the bond without
conversion feature.
 Conversion Premium
• Initial Conversion Premium
• Conversion Premium in Subsequent Year (The
premium results because the convertible offers fixed
income at a low risk of price decline while assuring
the chances of capital gains when the share price
increases)
 Market Value of Convertible
 Minimum Value of Convertible/Floor Value of
Convertible
 Call Policy on Convertible Bond
 Sweetening fixed-income securities
 Deferred equity financing: Selling ordinary
shares in future in a higher price.
 Avoiding earnings dilution.
 Raising low cost capital.
 Reduce Agency Cost
 Avoid negative signaling effect of issuing
stock directly.
1 Warrants are usually detachable and 1 Conversion option attached to a
sold separately. bond/preferred stock are not
detachable.
2 Exercise of warrants increases total 2 Total capital remains constant after
amount of capital. conversion.
3 Generally used privately. 3 They are usually issued publicly.

4 Company receives additional funds 4 No additional funds are received at

when warrants are exercised. conversion of convertible.
5 Warrants are not callable. 5 Convertibles can be called.

6 Bonds and preferred stock remain on the 6
company’s books after the exercise of
warrants.
7 Warrants are exercised under warrant 8
holders’ option as a result firms do not
have control over the timing of the
capital structure.
The fixed-income securities are
exchanged for common stock and taken
off the company’s books.
Because of the call feature, convertibles
give the firm greater control over the
timing of capital structure.
 Both are issued to attract investors.
 Reduces cost of capital for the firm.
 Both contain call option (investors receive option to gain
common shares at the exercise price or conversion price
even if the market value is much higher).
 Investors get the chance to receive fixed-income (from bond
or preferred stock) as well to benefit from capital gains due
to increase in share price.
 Both convertibles and warrants tend to lessen potential
conflict between fixed income security holders and
stockholders, thereby reducing agency costs.
 Both allow for deferred issuance of common stock at a price
higher than the prevailing market price.