6. Warrants Aa Aa Warrants are long-term options to buy a stated number of commo
ID: 2784723 • Letter: 6
Question
6. Warrants Aa Aa Warrants are long-term options to buy a stated number of common shares at a specified price; they are generally attached to debt issues. Which kind of firm is more likely to issue bonds with attached warrants-large, mature firms or small, fast-growing firms? O Large, mature firm:s O Small, fast-growing firms Consider the case of Yorkshire Pudding Co.. The company issued warrants that allow holders to purchase two shares of the company's common stock at an exercise price of$22.00 per share. These warrants were issued two years ago and are set to expire on October 1 two years from now. Zoya is an analyst who has been tracking Yorkshire Pudding Co.'s market performance and its impact on the equity offerings of the company. She submitted a report in January this year stating that the company's warrants were trading at a price of $4.88 each on January 1. The company's common shares were trading at $18.75 per share on the same day. Analysts expect Yorkshire Pudding Co. stock price to rise to $30.80 by October 1 two years from now. Based on your understanding of warrants, complete the following valuations in Zoya's report. Value Formula value of the warrants on January 1 (this year) Formula value of the warrants on October 1 (two years from now) Suppose that on October 1 (two years from now) the warrant is trading at a price of $26.40 per warrant. The premium over the formula value on October 1 will beExplanation / Answer
Small, fast growing firms because they have less fixed cash flows to pay out as interest and bonds with warrants would lower the interest rates
Warrants on January 1: value=max(S-X,0) where S is stock price, X is exercise price
Here, X=22, S=18.75..SO value=max(18.75-22,0)=0
Warrants on October 1: value=max(S-X,0) where S is stock price, X is exercise price
Here, X=22, S=30.80..SO value=max(30.8-22,0)=8.8
The premium if warrants are trading at 26.4 is 26.4-8.8=17.6
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