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) Exercise value = 35 - 30 = 5

b) Investor likely be willing to pay for the warrant over and above its exercise value = 35*1.3 - 35 = 10.5

Investor wiling to pay extra becasuse stock has beta of 1.3, it means stock price is derived undervalued based on extra risk of 30% involved in the stock.

c) If stock beta is 1 then investor will not be willing to pay more and will be willing to pay the intrinsic value only.

d) It is similar to call option as it gives right to buy.

e) Warrants can get the same dollar return as would realize by holding the stock but without investing full money for stock price therefore people prefer to buy warrants rather than stock.

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