Question

how to price warrant

from derivatives subject

Answer 1

A company may add warrants to newly issued shares of stock or to bonds as an incentive for investors. A warrant is a contract that grants you the right to buy shares of the company’s stock at a guaranteed price. After they are issued, warrants may be traded on stock markets. So far, warrants sound a lot like stock options. However, warrants usually are good for several years -- much longer than options. Companies issue warrants only for their own stock or that of subsidiaries.

To calculate the value of the warrants, you'll first need the exercise price. Typically, warrant exercise prices are set well above the stock's market price at the time of issue. For example, if the stock is selling for $25 per share when the warrants are issued, the exercise price might be $40 or more.

Find the conversion ratio, also called a gearing ratio, in the terms and conditions of the warrants. Typically, you must have more than one warrant to buy one share of stock. For example, the company might require five warrants to purchase one share of stock at the exercise price. The conversion ratio in this case is 5-to-1.

Look up the current market price of the stock. Subtract the exercise price from the market price to find the intrinsic value of the warrant. Suppose the market price is $50 per share and the exercise price is $40. This gives you an intrinsic value of $10 per share. Divide the intrinsic value by the conversion ratio to find the value of one warrant. In this example, if the conversion ratio equals five, you have $10 divided by five. One warrant is thus worth $2. If the market price is less than the exercise price, the warrants have no value because you could buy the shares on the market for less. Warrants acquire value only if the market price rises above the exercise price.