How best to allocate your funds?

To a certain extent, that depends on your risk appetite, which in turn hinges on your individual circumstances.

A risk-averse investor may hold more cash, and a risk-tolerant investor vice-versa.

Allocation will also depend on market conditions.

Equity risk premium can be a good guiding principle for asset allocation decisions, i.e., when to hold cash and when to hold stocks if you are looking at just 2 asset classes.

Even if you have high tolerance for risks, it would be foolish to allocate 80% of your portfolio to equities during a stockmarket bubble.

And even, if the market was "normal" when you allocated your assets, prices will move, leaving you holding more of one asset class than you desire. In which case, you might want to rebalance your portfolio.

Stocks, bonds or cash? How much you hold of each asset class - or asset allocation - is the most important decision in an investment process. Studies have shown that about 95% of variations in returns on portfolios are explained by asset allocation decisions. Only about 5% are due to other causes, such as security selection.

Ref: Show Me the Money by Teh Hooi Ling

When is the market over-valued?

The stock market moves in a cycle - from extreme optimism to extreme pessimism. How can you tell when stocks are under or over-valued vis-a-vis bonds or cash? Taking advantage of perceived over or under-valuation of securities in different asset classes can yield spectacular results.

Equity risk premium:

> 3.5%, market is undervalued
< 0.6%, market is overvalued.
0.6% to 3.5%, market is fairly valued.

Equity risk premium is the compensation investors require for holding stocks.

When the economic outlook is bad, or in the aftermath of a catastrophe, the equity risk premium will be high because fear grips investors and they can only be enticed to hold "risky" stocks if the promised returns are good.

Conversely, in good times everyone become over-confident of the continued good performance of stocks and will demand very little compensation to hold them.

Equity risk premium
= earnings yield (1/market PE) - the risk free rate.

Market PE ratios were obtained from Thomson Financial Datastream.
One-year deposit rates were taken as risk-free rates.

Ref: Show Me the Money by Teh Hooi Ling

My investment horizon is 10 or 20 years

Those with investment horizons of 10 or 20 years should be ever ready to embrace out-of-favour asset classes.

Time and again, the market has handsomely rewarded those willing to bear equity risk in uncertain times. Extreme pessimism - which leads to swings from the equilibrium - compresses a proverbial spring that will eventually bounce back into equilibrium. The more share price falls, the more return it promises a prospective buyer.

Stocks - short of the company going bankrupt - will very often produce their promised returns eventually; it is the timing that will elude us. So for those with time on their side, they have nothing to lose. In short, having an explicit investment plan supports discipline and helps ensure that an investor is not swayed by panic or overconfidence.

If one is investing for financial independence 20 or 30 years down the road, opportunities that came with Sept 11's after-shocks, the Asian financial crisis, or the recent Lehman crash, are not to be missed.

Ref: Show Me the Money by Teh Hooi Ling

Bursa Malaysia Aims for 40 Listings a Year, CEO Yusli Says

Bursa Malaysia Aims for 40 Listings a Year, CEO Yusli Says


By Chan Tien Hin

July 21 (Bloomberg) -- Bursa Malaysia Bhd., operator of the nation’s exchange, said it aims to attract as many as 40 new listings a year as the easing of investment rules in the country helps draw foreign investors.

Bursa attracted 23 listings last year and 26 in 2007, down from 40 three years ago, according to its Web site. Only one sold shares for the first time in the first half, it added.

“Over the next six months, if we get the same number as last year, that will be good,” Yusli Yusoff, Bursa’s chief executive officer, said in an interview in Kuala Lumpur. “I don’t see why we can’t continue the momentum, I’ve always said that in any year, we should be looking at 30 to 40 companies.”

Malaysian Prime Minister Najib Razak last month eased investment rules governing initial public offerings and takeovers, scrapping the need for overseas companies and publicly traded Malaysian businesses to set aside 30 percent of their equity to local ethnic Malay investors.

Najib, who took office in April, is overhauling the Southeast Asian nation’s financial markets to attract investors and revive an economy that’s facing its first contraction in a decade. The benchmark FTSE Bursa Malaysia KLCI has risen 30 percent this year, lagging behind regional markets.

The measure’s gap with Southeast Asian indexes may widen. Macquarie Group Ltd. said in a report today that investors should “take profit” in Malaysian stocks as “liquidity and earnings upgrades are showing signs of fatigue.”
‘Big Ones’

Bursa said more than 20 companies are already in the “pipeline” for initial share sales, including a handful of businesses from China, with more expected following the easing of investment rules.

“We expect companies who previously may not have wanted to come to the market because of this condition to now come forward,” Yusli said today. “I want some big ones this year.”

The bourse said discussions with Southeast Asia’s stock exchanges to develop an electronic trading link connecting five markets in the next two to three years are at a “fairly advanced stage.”

Southeast Asia’s stock exchanges signed a preliminary agreement on Feb. 23 to develop a trading link to boost competitiveness and lure more overseas funds into the region.

To contact the reporter on this story: Chan Tien Hin in Kuala Lumpur at thchan@bloomberg.net

Last Updated: July 20, 2009 23:12 EDT

Warren Buffett's Priceless Investment Advice

Warren Buffett's Priceless Investment Advice
By John Reeves
July 19, 2009


"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

If you can grasp this simple advice from Warren Buffett, you should do well as an investor. Sure, there are other investment strategies out there, but Buffett's approach is both easy to follow and demonstrably successful over more than 50 years. Why try anything else?

Two words for the efficient market hypothesis: Warren Buffett

An interesting academic study (PDF file) illustrates Buffett's amazing investment genius. From 1980 to 2003, the stock portfolio of Berkshire Hathaway (NYSE: BRK-B) beat the S&P 500 index in 20 out of 24 years. During that same period, Berkshire's average annual return from its stock portfolio outperformed the index by 12 percentage points. The efficient market theory predicts that this is impossible, but the theory is clearly wrong in this case.

Buffett has delivered these outstanding returns by buying undervalued shares in great companies such as Gillette, now owned by Procter & Gamble. Over the years, Berkshire has owned household names such as UPS (NYSE: UPS), Iron Mountain (NYSE: IRM), and Wal-Mart (NYSE: WMT).

Although not every pick worked out, for the most part Buffett and Berkshire have made a mint. Indeed, Buffett's investment in Gillette increased threefold during the 1990s. Who'd have guessed you could get such stratospheric returns from razors?

The devil is in the details
So buying great companies at reasonable prices can deliver solid returns for long-term investors. The challenge, of course, is identifying great companies and determining what constitutes a reasonable price.

Buffett recommends that investors look for companies that deliver outstanding returns on capital and produce substantial cash profits. He also suggests that you look for companies with a huge economic moat to protect them from competitors. You can identify companies with moats by looking for strong brands that stand alongside consistent or improving profit margins and returns on capital.

How do you determine the right buy price for shares in such companies? Buffett advises that you wait patiently for opportunities to purchase stocks at a significant discount to their intrinsic values -- as calculated by taking the present value of all future cash flows. Ultimately, he believes that "value will in time always be reflected in market price." When the market finally recognizes the true worth of your undervalued shares, you begin to earn solid returns.

Do-it-yourself outperformance
Before they can capture Buffett-like returns, beginning investors will need to develop their skills in identifying profitable companies and determining intrinsic values. In the meantime, consider looking for stock ideas among Berkshire's own holdings.

In the Form 13-F that Berkshire filed recently, we learned that Buffett has boosted his stake in financials, adding to existing positions Wells Fargo (NYSE: WFC) and U.S. Bank (NYSE: USB).

It's pretty clear that Buffett thinks these conservatively run banks represent compelling investment opportunities at the moment. In fact, Buffett claimed in May that if he had to put all of his net worth into a single stock, it would be Wells Fargo.

Despite Buffett's confidence, it's clear that many individual investors are still afraid of financial stocks. If you fall into that camp, another place to find great value-stock ideas is Motley Fool Inside Value. Philip Durell, the advisor for the service, follows an investment strategy very similar to Buffett's.

He looks for undervalued companies that also have strong financials and competitive positions. This approach has allowed Philip to outperform the market since Inside Value's inception in 2004. To see his most recent stock picks, as well as the entire archive of past selections, sign up for a free 30-day trial today.

If investing in wonderful companies at fair prices is good enough for Warren Buffett -- arguably the finest investor on the planet -- it should be good enough for the rest of us.

Already subscribe to Inside Value? Log in at the top of this page.

This article was originally published on April 7, 2007. It has been updated.

John Reeves can't remember the last time he used a razor made by someone other than Gillette, and he wishes he'd owned shares in that company before P&G acquired it. John does not own shares of any companies mentioned. The Motley Fool owns shares of Berkshire Hathaway and Procter & Gamble. Berkshire and Wal-Mart are Inside Value recommendations. Berkshire is also a Stock Advisor selection. UPS and P&G are Income Investor picks. The Fool has a disclosure policy.

Marc Faber: The next bubble being inflated right now

Faber: Next Stimulus Will Be Worse

Wednesday, July 15, 2009 3:46 PM

By: Julie Crawshaw Article Font Size

Some economists think that another bubble is what’s needed to get the economy moving again.

Gloom, Boom and Doom publisher Marc Faber said this is ridiculous, and that the Federal Reserve — which he holds responsible for creating the housing bubble — wants to do it all over again.

The central bank should not encourage excessive credit growth, Faber tells Moneynews.com's Dan Mangru in an exclusive interview.

Between 2000 and 2007 the total U.S. credit market debt increased at five times the rate of nominal gross domestic product.

Unfortunately, Faber said, the next bubble is already here. This time it’s government spending and fiscal deficits that Faber thinks will double the government’s debt during the next six years or less.

“The U.S. government is largely deranged,” he said. “The private sector is the dynamic one, and that’s why I object tremendously against building up fiscal deficits because (they) shift economic activity into unproductive government instead of leaving it in the private sector.”

Another stimulus package would only make matters worse.

“In the Depression, they had one stimulus after another and it didn’t help,” Faber said. “What helped was World War II.”

The problem with bubbles, Faber said, is that they only temporarily stimulate the economy.

“The whole economic expansion driven by a bubble in America has been a total disaster and has shifted wealth from the ordinary people who work … to the Wall Street elite,” he said.

Nor does the government score any higher when it comes to managing inflation, which Faber thinks will reach Zimbabwe-like levels in the U.S. courtesy of the Fed’s policy of keeping interest rates too low.

“The Fed, in my opinion, has zilch idea about monetary policy,” Faber said.

“What they focus upon is basically core inflation, which does not include energy and food prices and the way the Fed measures inflation is highly questionable in the first place because when you measure inflation it’s a basket of goods and services.”

When the economy recovers, interest rates should go up because of inflationary pressures, something Faber expects the Fed won’t let happen because it could cause interest payments on the government’s debt to double. Those payments today are slightly below $500 billion annually.

If the global economy collapses in a deflationary spiral, those government deficits actually expand, leading to more central bank-driven monetization, Faber said. And keeping interest rates artificially low will lead to more and more inflation.

Add to all of this the expectation that health care costs will soar and jobless rates will probably continue to be high, and the economic picture becomes even gloomier.

“I think we’ve just gone … to the beginning of the realization that the economy may be bottoming out but not much recovery is forthcoming,” Faber said.

© 2009 Newsmax. All rights reserved.

http://www.thedailycrux.com/content/2349/Economy/eml

http://moneynews.newsmax.com/streettalk/federal_reserve/2009/07/15/235992.html

The biggest assumption and risk for investors: Earning Forecast

The biggest assumption in any valuation model is the earning forecast.

We have assumed that the earning forecasts by various analysts are good and accurate. This is the biggest risk investors have to face.

In general, investors can use consensus earning forecasts for computing the valuation, however, through experience, investors can identify good analysts from not so good ones, and hence, can be selective in using the earning forecast data.

Bear in mind that a way-off-earning forecast (especially over-bullish) could have disastrous effects on the stock price once the actual result is announced.

A good practice is to compare the forecast EPS growth rate with the averge EPS growth rate in the past three years and see whether the forecast EPS growth rate is in line with the historical numbers.

In short, what investors are looking for is an accurate EPS growth forecast.

Analysts' earnings forecasts

Investors should be aware that in an up cycle, analysts would do two things:

1. to upgrade the earning forecast almost on a regular basis, and,
2. to accord the stock on a higher valuation (i.e. stock is now valued at a higher PE ratio).

This, we call, earning expansion and PE ratio expansion.

Normally, the analysts would do this a couple of times during a complete up cycle.

In a down cycle, the reverse happens. That is, earning and PE ratio (valuation) contract.

For those who have been investing over the last 4 years, they would have observed these in the analysts reports during the bull and the bear phases of the market.

What lessons should we learn from this?

We should not be sucked into this as we know that a very high EPS forecast is not sustainable (as compared to its historical records), and hence disappointment or downgrade would ahve to occur and we need to get out of this before it happens.

Thus, it is very important to know the big picture to gain an inkling of which stage of the economic cycle we are in now and how it is going to move looking forward.

Hence, when we look at EPS growth, we should ask ourselves whether it is sustainable in the next few years.

PE ratio, PEG and EPS Growth rates

A high PE ratio by itself means that either

• the valuation is very expensive (where the stock price is high as compared to its EPS) or
• it has such great potential for growth that investors are willing to accord it with a high PE ratio.

In general, the lower the PE ratio, the better it is.

For high growth stocks, we also look at the PEG ratio (PE ratio/ EPS Growth rate). For high growth stocks, their PE ratio if viewed on absolute basis is usually very high. How do we then decide if it is still "cheap" enough for us to hold or even buy? We use the PEG ratio to see whether its growth is at a faster rate as compared to its appreciation in value (i.e. high PE ratio). If PEG is low despite a high PE ratio, this would indicate the growth in earning (higher EPS growth) is much faster than the increase in its valuation (higher PER), and hence could justify our holding or even buying the stock.

Public Bank records RM1.54b pre-tax profit in H1

Monday July 20 2009.

KUALA LUMPUR, July 20 — Public Bank Bhd posted a pre-tax profit of RM1.564 billion in the first half of the year year ended June 30, 2009 compared with RM1.76 billion in the same period last year.

Revenue declined to RM4.78 billion from RM5.15 billion previously.

In a statement today, the bank said net interest and financing income grew by nine per cent to RM180 million, driven by its expanding loan and deposits businesses and sustained strong assets.

It said total assets crossed the RM200 billion mark for the first time, standing at RM204.0 billion as at end-June 2009.

Total loans and advances grew by RM8.7 billion, or 7.2 per cent, in the first six months of 2009, to RM129.4 billion, significantly above the banking industry’s 1.2 per cent for the first five months of 2009, it said.

Public Bank said core customer deposits grew by 11.5 per cent in the first six months of 2009 to RM125.3 billion compared with the industry’s 2.9 per cent during the first five months of 2009.

As at the end-May 2009, Public Bank’s domestic market share of total loans and core customer deposits rose to 15.5 per cent and 15.2 per cent respectively compared with 14.8 per cent and 14.7 per cent respectively as at Dec 31, 2008, it said.

It said the group's net non-performing loan ratio was below one per cent as at end-June 2009, significantly lower than the industry’s 2.2 per cent in May 2009.

The group’s loan loss coverage of 173 per cent was about twice the banking industry’s ratio of 87 per cent, and continued to be the highest and most prudent in the Malaysian banking industry, it said.

On outlook, it said, despite the slowing economy, the banking industry in Malaysia remained resilient, supported by its strong capitalisation, stable asset quality and improved risk management practices.

Hence, it said, the group would continue to pursue its strategy of strong organic business growth, as well as maintain a high quality loan portfolio and improved productivity.

"Barring unforeseen circumstances, the group is expected to continue to record satisfactory performance for the rest of 2009," it said. — Bernama

Wake up Malaysians. “What has this country come to?”

What has this country come to?

There had been so many unexplained and unresolved incidences. Altantunya, Kugan, and now Teoh. There are also many issues, like Lingam tapes, alleged corruptions in high places, abuses of public offices and others.

When some lawyers mentioned in 1998 that if such an "event" can happen to Anwar, then the deputy PM, it may happen to anyone. They were not mincing their words.

Politics in this country is very partisan. Even the recent tragedy of Teoh, which should have provoked a bipartisan response, was debated by some "significant" politicians in a partisan manner. Surprisingly, too many remain silent on this important issue. This is truly saddening.

Where is the sense of right and wrong in these politicians and certain national papers.

Wake up Malaysians.

Market risk or systemic risk

This risk cannot be eliminated by diversifying one's portfolio.

Definitions of Market risk on the Web:

Market risk is the risk that the value of an investment will decrease due to moves in market factors. The four standard market risk factors are: * Equity risk, the risk that stock prices will change. * Interest rate risk, the risk that interest rates will change. ...en.wikipedia.org/wiki/Market_risk

The possibility that the value of an investment will fall because of a general decline in the financial markets.www.waddell.com/jsp/index.jsp

The chance that a security's value will decline. With fixed income securities, market risk is closely tied to interest rate risk--as interest rates rise, prices decline and vice versa.www.netxclientdemo.com/invest_glosry_MMa.htm

Exposure to changes in market prices.www.info-forex.com/glossary.htm

Also called systematic risk. The portion of a security’s risk common to all securities in the same asset class, and that cannot be eliminated through diversification.www.manealfinancial.com/Glossary-MtoZ.htm

One of six risks defined by the Federal Reserve. The risk of an increase or decrease in the market value/price of a financial instrument. Market values for debt instruments are affected by actual and anticipated changes in prevailing interest rates. ...www.americanbanker.com/glossary.html

Exposure to a change in the value of some market variable, such as interest rates or foreign exchange rates, equity, or commodity prices.www.fhlb.com/Glossary.html

Market risk refers to the risk of financial loss as a result of adverse market movements. NZDMO specifically measures market risk with regard to movements in interest rates and foreign exchange rates.www.oag.govt.nz/2007/nzdmo/glossary.htm

The value of a security may decline due to general market conditions that are not specifically related to a particular company, such as real or perceived adverse economic conditions, changes in the outlook for corporate earnings, changes in interest or currency rates or adverse investor ...www.dreyfus.com/content/dr/control

Uncertainty in the value of real estate due to market, economic, political or other conditions.www.new-york-new-york-real-estate.com/m2.html

The risk of loss resulting from changes in the prices of financial instruments in the markets in which Chase participates, such as changes in the value of foreign exchange or fixed-income securities.https://www.chase.com/inside/financial/annual/glossary.html

Risk that cannot be diversified away. Related: systematic riskbiz.yahoo.com/glossary/bfglosm.html

Risk relating to the market in general and cannot be diversified away by hedging or holding a variety of securities.charmforex.com/index.php

Risk of loss due to unfavourable price changes on the financial markets.www.ingwholesalebanking.com/smartsite.shtml

risk that comes from customers not wanting to buy a product, the market being smaller than originally estimated, or a competitor launching a competing product. http://www.google.com/url?&q=http://www.epilepsy.com/innovation/entrepreneurs/glossary&ei=FexiSvKmMZWBkQWf1antDw&sa=X&oi=define&ct=&cd=1&usg=AFQjCNFChX-S8PEUc0fWkKKMwHxGc_shwA

Has the share price discounted all the negatives?

In a downturn, or a crash, the price of a stock may go down by a large amount. After the price has stabilised, the question to ask oneself, would be: "Has this share price discounted all the negatives?" Re-value this stock again using its latest fundamentals. It may be a rewarding exercise.

Wake up Malaysians. “What has this country come to?”

The MACC is a highly efficient body. However, it has not been unnoticed that this body moves very fast in certain cases, and suffers severe malaise in others. A very sad situation reflecting the political culture in this country. Wake up Malaysians.

Covered Warrants

Covered Warrants on the London Stock Exchange

In October 2002, the LSE launched a market in covered warrants. Its first year was a resounding success, with 823 new issues and trading volume of GBP97 million.

A covered warrant is essentially an option. Unlike the traditional "corporate" warrant, which is issued by the underlying company, a financial institution issues the covered warrant.

Goldman, Sachs, and JP Morgan, are notable players in this market.

Covered warrants are sometimes referred to as securitised derivatives.

Whereas the typical corporate warrants gives the holder the right to buy shares directly from the company (like a call option), the covered warrant comes in may forms:

• some (put warrants) carry the right to sell rather than to buy,
• some are based on foreign exchange or commodities rather than on stock, and,
• some have complicated exercise terms.

http://www.klse.com.my/website/bm/market_information/market_statistics/equities/downloads/call_warrants.pdf

Characteristics of warrants

A warrant is a non-dividend paying security giving its owner the right to buy a certain number of shares at a set price directly from the issuing company. These usually have an initial life of between 3 and 5 years.

Characteristics

Warrants are often issued in conjuction with a new debt issue.

Including a warrant with the bond enables the issuing firm to float the bond issue at a lower interest rate than would otherwise be required. This may be the primary motivation for their issuance.

Warrants can be detachable and nondetachable, although the former are more important for our purposes. Detachable warrants may be sold separately from their accompanying debt issue. A nondetachable warrant cannot be sold separately.

Warrants pay no dividends, and they carry no voting rights. Their principal investment attraction is the leverage they provide; the warrant price is less than that of the corresponding common stock, and consequently warrant investments magnify the effect of stock price movements.

Warrants can have unusual exercise terms and conditions. The Standard & Poor's Stock Guide listing for many warrants indicates "terms and trading basis should be checked in detail." The majority of US warrants are from small, relatively risky firms. Newly issued warrants usually originate in conjunction with an initial public offering.

Some warrants are called "B" warrants. These come about from the exercise of an "A" warrant that allows its owner to trade the warrant for shares of stock and a "B" warrant with a higher exercise price than the "A" warrant.

Looking at warrant population by stock price range, the majority are from a firm whose stock price is low. While there may be no inherent reason why a low-priced stock should be risky, it is an empirical observation that a low stock price is frequently associated with higher relative risk.


A warrant is much like a long-term call option issued by the underlying company. The warrant holder has the right but not the obligations, to buy shares at a set price during the life of the warant. Warrants provide leverage in the same fashion as an option.

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.

Extending the life of out-of-the-money warrant

Companies sometimes extend the life of an out-of-the-money (stock price is less than exercise price) warrant as it nears expiration. The exercise of warrants is a relatively inexpensive source of new capital for the firm. Management may not want to let the opportunity pass.

Extending the life of a warrant will immediately add value to it. A nearly worthless expiring warrant is likely to jump several dollars in value if the firm extends its life a few years.

The actual price change would depend on:

• the stock/exercise price relationship,
• the added term of the warrant, and
• the anticipated volatility of the stock over the extension period.

Pricing of Warrants (illustrations)

Illustrations

AR warrant.

Exercise price $7.32
Current stock price $11.95
This warrant is in-the-money.
It must sell for at least its intrinsic value of $11.95-$7.32 = $4.63, which it does.
Market price of warrant $5.00, represents a $0.37 premium over the warrant's intrinsic value.


GC warrant

4 warrants to buy 1 share at $6.60
Current stock price $19.72
What is the minimum value for which this warrant should sell?

Current stock price > exercise price by $19.72-$6.60 - $13.12.
This amount would be the intrinsic value of the warrant if each warrant permitted the purchase of one share.

Because 4 warrants are required, the intrinsic value declines proportionately: $13.12/4 = $3.28.

This amount is the minimum value at which the warrant should sell.

http://www.klse.com.my/website/bm/market_information/market_statistics/equities/downloads/warrants_info.pdf

Pricing of Warrants

The most important factor influencing the market price of a warrant is the relationship between the price of the underlying common stock and the price at which the investor may buy shares - the exercise price.

The warrant is in-the-money: stock price > exercise price
The warrant is out-of-the money: stock price < exercise price.

When the warrant is in-the-money, it has intrinsic value.

Minimum, maximum and actual market values of a warrant.

If it takes one warrant to buy one shae of stock, then the effective exercise price is the same as the stated exercise price.

If however, a single warrant with an exercise price of $10 allows you to buy 2 shares of a stock, the effective exercise price is $5.

Effective exercise price = Exercise price/conversion ratio

As Standard & Poor's warns, "trading terms and basis should be checked in detail." An investor should always check the effective exercise price, which is the stated exercise price divided by the conversion ratio. It is the amount of money needed to buy one share of the stock.

Assuming a conversion ratio of 1:1, it would not make sense for the warrant to ever sell for more than the value of the underlying asset. The theoretical maximum price of a warrant is therefore equal to the stock price. (For instance, if one share of the stock sells for $25, no rational person would be willing to pay more than $25 for the right to buy a share, even if the warrant exercise price were zero.)

The theoretical minimum value is the warrant's intrinsic value. This is the greater of zero and the amount by which the stock price exceeds the exercise price. (Given a stock price of $25 and an exercise price of $20, this warrant should always sell for at least $5. If not, arbitrage would be present.)

Actual warrant prices fall between the two extremes. The gap between the market price of the warrant and its minimum value is largest when the stock price equals the exercise price. As the stock price rises or falls from this point, the gap narrows.