Thursday 16 July 2009

Understanding Warrant

For example:

WARRANTS xx07/xx16
- new ordinary share at an exercise price of RM0.40 per ordinary share.
- The exercise period is 9 years from the date of issuance which will expire on xx, May xx16.

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Illustration:-

Today's Share Price: 14.40
Warrant's Price: 10.80
Exercise Price: 5.30
Quantity: 60,000,000 free detachable warrants


In-the-money:

Market price of mother share > exercise price

Intrinsic value of warrant
= Market share price - Exercise price of warrant
= 14.40 - 5.30 = 9.10.

Therefore, you can exercise your right to buy the mother share at the exercise (lower) price to sell at the market (higher) price.

Premium:

Premium paid for the warrant
= Warrant market price - Intrinsic value of warrant
= 10.80 - 9.10
= 1.70

The premium paid is 1.70 (1.70/9.10 = 18.7%) over the warrant's intrinsic value.

Premiums (over the warrant's intrinsic value) are commonly used as a quick measure of the warrant's expensiveness. Because warrants are issued at a premium, investors must consider if it can appreciate to a level that allows recovery of the paid premium within the warrant's lifespan.

While warrants can offer a smart addition to a portfolio, keep in mind the following - your view of the underlying share is important; understand the unique nature of warrants and stay attentive to small movements in the market.


Cash extraction:

Assuming mother share increased to $2.00 and warrants also increased, to $1.58.

One can sell the mother share and invest some of these money into its warrants. Effectively, you would have decreased your invested capital (extracted cash of 0.42 per share) while maintaining exposure to further upside.

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