WARRANTS &

CONVERTIBLES
WARRANTS
Warrant is a security that entitles the holder to buy the underlying stock of the issuing co. at a fixed price
called exercise price until the expiry date. In simple terms Warrants are a derivative that give the right, but
not the obligation, to buy or sell a security—most commonly an equity—at a certain price before
expiration.
Warrants are similar to options, here, two contractual financial instruments allow the holder special rights
to buy securities. Both are discretionary and have expiration dates.

Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay
lower interest rates or dividends. They can be used to enhance the yield of the bond and make them more
attractive to potential buyers. Warrants can also be used in private equity deals.

Frequently, these warrants are detachable and can be sold independently of the bond or stock.
BENEFITS OF
WARRANTS
For Company For Shareholders
• The company has more opportunities to expand its • Shareholders will benefit from issuing warrants if the
investor base, as those investing in warrants can be exercise price is less than the market price. Thus,
different from those buying the company’s ordinary shareholders will be able to buy ordinary shares for less
shares. than the market price, or “in-the-money”.
• As warrant holders exercise their rights, the company’s • The investment cost of warrants is generally lower than a
number of ordinary shares will increase and consequently direct investment in ordinary shares. Additionally, the
boost stock liquidity in the market market price of warrants is usually more volatile than the
company's stock movement.
• Issuing warrants along with other financial instruments
will increase attractiveness and reduce the funding cost of • The rights offering warrant will reduce the dilution effect’s
the financial instruments offered. impact, as shareholders are able to choose whether they
would like to exercise their warrants or not.
TYPES OF WARRANTS
A wide range of warrants and warrant types are available. The reasons you might invest in one type of warrant
may be different from the reasons you might invest in another type of warrant.
Equity warrants: Equity warrants can be call and put warrants.
Covered warrants: A covered warrants is a warrant that has some underlying backing, for example the issuer
will purchase the stock beforehand or will use other instruments to cover the option.
Basket warrants: As with a regular equity index, warrants can be classified at, for example, an industry level.
Thus, it mirrors the performance of the industry.
Index warrants: Index warrants use an index as the underlying asset
Wedding warrants: are attached to the host debentures and can be exercised only if the host debentures are
surrendered
Detachable warrants: the warrant portion of the security can be detached from the debenture and traded
separately.
Naked warrants: are issued without an accompanying bond and, like traditional warrants, are traded on the
stock exchange.
Cash or Share Warrants in which the settlement may be in the form of either cash or physical delivery of the
shares - depending on its status at expiry.
HOW WARRANTS WORK
For example, if Company XYZ issues bonds with warrants attached, each bondholder might get a $1,000
face-value bond and the right to purchase 100 shares of Company XYZ stock at $20 per share over the next
five years. Warrants usually permit the holder to purchase common stock of the issuer, but sometimes they
allow the purchaser to buy the stock or bonds of another entity (such as a subsidiary or even a third party).

The price at which a warrant holder can purchase the underlying securities is called the exercise price
or strike price. The exercise price is usually higher than the market price of the stock at the time of the
warrant's issuance. In our example, the exercise price is $20, which is 15% higher than what Company
XYZ stock was trading at when the bonds were issued. The warrant's exercise price often rises according to
a schedule as the bond matures. This schedule is set forth in the bond indenture.
HOW WARRANTS WORK
If the price of the stock is above the exercise price of the warrant, the warrant must have what is known as
a minimum value. For example, consider the warrants to purchase 100 shares of Company XYZ for $20 per
share anytime in the next five years. If Company XYZ shares rose to $40 during that time, the warrant
holder could purchase the shares for $20 each, and immediately sell them for $40 on the open market,
pocketing a profit of ($40 - $20) x 100 shares = $2,000. Thus, the minimum value of each warrant is $20.

It is important to note, however, that if the warrants still had a long time before they expired, investors
might speculate that the price of Company XYZ stock could go even higher than $100 per share. This
speculation, accompanied by the extra time for the stock to rise further, is why a warrant with a minimum
value of $20 could easily trade above $20. But as the warrant gets closer to expiring (and the chances of the
stock price rising in time to further increase profits get smaller), that premium would shrink until it equaled
the minimum value of the warrant (which could be $0 if the stock price falls to below $20).
CONVERTIBLE BONDS
Convertible bond or convertible note or convertible debt (or a convertible debenture if it has a maturity of
greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common
stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features.

Convertible bonds are most often issued by companies with a low credit rating and high growth potential.
Convertible bonds are also considered debt security because the companies agree to give fixed or floating
interest rate as they do in common bonds for the funds of investor. To compensate for having additional value
through the option to convert the bond to stock.

From the issuer's perspective, the key benefit of raising money by selling convertible bonds is a reduced cash
interest payment. The advantage for companies of issuing convertible bonds is that, if the bonds are converted
to stocks, companies' debt vanishes.
Convertible notes are also a frequent vehicle for seed investing in startup companies, as a form of debt that
converts to equity in a future investing round
TYPES OF CONVERTIBLE BONDS
• Vanilla convertible bonds are the most plain convertible structures. They grant the holder the right to
convert into a certain number of shares determined according to a conversion price determined in advance.

• Mandatory convertibles are a common variation of the vanilla subtype, especially on the US market.
Mandatory convertible would force the holder to convert into shares at maturity—hence the term
"Mandatory". Those securities would very often bear two conversion prices, making their profiles similar to
a "risk reversal" option strategy.

• Reverse convertibles are a less common variation, mostly issued synthetically. They would be opposite of
the vanilla structure: the conversion price would act as a knock-in short put option: as the stock price drops
below the conversion price the investor would start to be exposed the underlying stock performance and no
longer able to redeem at par its bond. This negative convexity would be compensated by a usually high
regular coupon payment.
TYPES OF CONVERTIBLE BONDS
• Packaged convertibles or sometimes "bond + option" structures are simply a straight bonds and a call
option/warrant wrapped together. Usually the investor would be able to then trade both legs separately.
Although the initial payoff is similar to a plain vanilla one, the Packaged Convertibles would then have
different dynamics and risks associated with them since at maturity the holder would not receive some cash
or shares but some cash and potentially some share
HOW DO CONVERTIBLE BONDS WORK
All convertible bonds have a conversion price. This price can be expressed in different ways and is almost
always substantially higher than the stock price at the time of bond is issued.

Assuming that you purchase a $1000 new convertible bond and the stock price of the company is trading at $10
at the time of the purchase, the bond might have a conversion price of “$15”.  In other words, for each “$15” of
the bond’s face value, you can have 1 share of stock.  To find out how many shares that you would get on
conversion, you would divide the face value by $15 ($1000/$15). You would receive 66 ⅔ shares per bond. “66
⅔” is called the conversion ratio.

Another term you may hear is the conversion premium. This is the percentage the stock would have to go up in
value to make a conversion profitable for the investor. In the case above, the stock would have to increase from
$10 to $15, so the conversion premium is 50%.

When the stock price of the issuing company starts getting close to the conversion price, the convertible bond
starts to trade more like a stock than a bond. Most convertible bond holders are going to wait for the stock to
have a big gain before converting.  If the stock  has a small gain but then the falls back, the bond holder will be
glad that he or she did not convert into stock. However, if the stock has a big gain, the bond holder will then
have to convert his or her shares and sell them to capture the gain
HOW DO CONVERTIBLE BONDS WORK
For example, Twitter (TWTR) issued a convertible bond, raising $1.8 billion in September 2014. The notes
were in two tranches, a five-year due in 2019 with a 0.25% interest rate, and a seven-year due in 2021 at 1%.
The conversion rate is 12.8793 shares per $1,000, which at the time was about $77.64 per share. The price of
the stock has ranged between $35 and $56 over the last year.

To make a profit on the conversion, one would have to see the stock more than double from the $35 to $40
range. The stock certainly could double in short order, but clearly, it's a volatile ride. And given a low-interest
rate environment, the principal protection isn't worth as much as it might otherwise be.
Thank You