Warrants and leverage

Speculators buy warrants because of the leverage they provide.

Example:

CBrand
Number of warrants to buy 1 share: 1
Exercise price: $19.23
Expiration: 3-10-09
Warrant price: $10.00
Stock price: $27.46

Suppose someone believes that CBrand is an attractive investment and wants to put about $5000 into the company. The speculator could buy either:

$5000/$10 per warrant = 500 warrants

or

$5000/$27.46 per share = 182 shares

Suppose at the end of the warrant's life in 2009, CBrand stock sells for $40.00.

With an exercise price of $19.23, the warrants would be worth $40.00 - $19.23 = $20.77.

The holding of 500 warrants would be worth $10,385.
The 182 shares of stock would be worth $7,280.

The respective holding period returns are as follows:

Warrants: ($10,385 - $5,000)/$5,000 = 107.7%
Stock: ($7,280 - $5,000) / $5,000 = 45.6%

CBrand pays a dividend, so the value of the dividend should be included in the stock holding period calculation in order for the comparison to be fair. Shareholders are entitled to declared dividends; warrant holders are not.