Company Z issued bonds with detachable warrants several years ago. Each warrant

Question

Company Z issued bonds with detachable warrants several years ago.   Each warrant allows the holder to purchase one share of stock at $30 per share.    The stock has a beta of 1.3.

a Calculate the exercise value of the warrants if the price of the underlying stock is $35.

b. How much would an investor likely be willing to pay for the warrant over and above its exercise value? Why?

c. Would the investor likely be willing to pay more or less for the warrant if the stock had a beta of 1.0? Why?

d. Is a warrant more similar to a call option or a put option? Why?

e.   Why might an investor prefer to buy warrants rather than the underlying stock?

Explanation / Answer

a. The exercise or strike price is the amount that must be paid in order to either buy the call warrant or sell the put warrant.so exercise price is $ 30 as given in question to purchase 1 warrant.

b.Investors are willing to pay a premium (time value) over the intrinsic value because of the remaining life of the warrant. As the exercise price is fixed, any future increase in the share price up to the warrant expiry, will be reflected by commensurate gains in the intrinsic value. and in present case stock of beta is 1.3 so, fluctuation in share price in compare to index is higher, so investor will pay premium for the stock.

c. if stock beta is 1.0 , then fluctuation in share price is will be same as fluctuation in index (market). so investor only like to pay instrinsic value for the warrent. as there is no more benefit in time value.

d. Yes. warrent and option are securities that are quite similar in many respects, but they also have some notable differences. A warrant is a security that gives the holder the right, but not the obligation, to buy a common share directly from the company at a fixed price for a pre-defined time period. Similar to a warrant, a call option (or

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