Value of a warrant, Financial Management

Value of a Warrant:

The market price of a warrant fluctuates between minimum and maximum limits. When the current market price of the stock Ps is greater than the exercise price Pe, the minimum value (Mv) is given by,

Mv = (Ps - Pe) x N, where, N is the number of shares.

When the current market price is lower than the exercise price, then the minimum value is zero, as there is no gain from exercising it.

If the warrant price was lower than this value, any investor by arbitrage would make risk-free profits. This is explained below.

Assume the market price of the share to be Rs.40, the warrant price Rs.4 and the exercise price Rs.33. Under these conditions, the total investment by the trader would be Rs.37 (to buy the warrants, exercise them and sell away the shares) and when he sells the underlying share he will realize Rs.40 ignoring the transaction costs. On the whole, he makes a profit of Rs.3. Therefore, the market price of the warrant should at least be equal to the minimum value.

The maximum value of the warrant is given by Ps x N. The warrant holders can realize this maximum value as they do not receive any dividend on the underlying stock during the period they hold the warrant.

Warrant Premium

The difference between the warrant price and the minimum value of the warrant is called the warrant premium. Usually, the magnitude of the premium over the intrinsic value for a given change in the stock and the exercise price depends on factors like the expiration period, variability in the stock price and the leverage provided by the warrant.

Let us consider the leverage effect it provides. Assume the stock's current market price to be Rs.33 and the warrant price Rs.7. After one month assume that the price of the stock increased to Rs.35 with a simultaneous increase in the warrant to Rs.9. The percentage change in price of the share is given by (35 - 33)/33 = 5.71%. And the percentage change in the warrant price is given by (9 - 7)/7 = 28.57%. Therefore, a warrant holder will experience a rise of 28.57% for a similar absolute change in the price of the share. The leverage effect acts in a reverse direction when the price of the underlying stock decreases.


Posted Date: 9/10/2012 8:02:42 AM | Location : United States

Related Discussions:- Value of a warrant, Assignment Help, Ask Question on Value of a warrant, Get Answer, Expert's Help, Value of a warrant Discussions

Write discussion on Value of a warrant
Your posts are moderated
Related Questions
What can be the reason for the negative synergistic gains for British acquisitions of U.S. firms? Negative synergies for British acquisitions of U.S. firms (united state firms) m

Modified duration is used to determine the percentage change in the bond's prices for a 100 basis point (1%) change in the yield. The underlying assumption is tha

The salaries paid in 2004 is Rs.500000; salaries outstanding Rs.20000; salaries paid in advance for 2001 is Rs.30000. What is the actual salary expenditure for 2004?

The production department in any firm is concerned with provision of production facilities, production cycle, skilled and unskilled labor, storage of finished goods, capacity utili

Why do we focus on cash flows in place of profits when evaluating proposed capital budgeting projects? We focus on cash flows in place of profits while evaluating proposed capita

Q. Explain about economic order quantity? The economic order quantity (EOQ) model is basis on a cost function for holding inventory which has two terms: holding costs as well a

Why auditors need to attain audit evidence When significant fluctuations/unexpected relationshipsare identified which are inconsistent with  other  relevant  information  or  t

Dividends and interest payments Payment  of  dividends  and  interest  can  either  be  demonstrated under financing activities or  under operating activities. Sum of the 3

Absolute Performance Standard is a method of measuring an organization's development and how effective and efficient it is at operating its business. The absolute performance stand

Q. Aggressive Approach of financial management? A -firm may be aggressive in financing its assets. An aggressive policy is said to be followed by the firm when it uses short-te