Question

Foundations of Financial Management: Define and discuss warrants and convertibles including what they are, how they work and how they effect the value of the bonds to investors

Answer 1

Warrants are derivative securities that give the bond holder the right to purchase a specified number of shares at a stated price. Bonds with warrants are just a variant on convertible bonds. The investor is entitled, through a warrant, to buy shares at a fixed cash price in future. On the other hand convertibles are derivative securities in the form of bond in which investors can convert their bonds into specified number of shares of common stock.

Warrants entail cash inflows for a company because when warrants are exercised new shares are purchased by the bond holders. In case of convertibles there is no additional fund that is received by a company as the debt is converted into equity.

Warrants affect the value of bonds in a direct manner through the minimum value of the attached warrant. This is because the higher the minimum value of the attached warrants, the higher the value of the bond. In case of convertibles the value of bonds are affected directly by the value of the stocks. In general, the price of a convertible bond will move in tandem with the price of the common stock, so if the stock price falls, the convertible bond price will follow suit.