Warrants are securities issued by a company (often an investment trust) which give their owners the right to purchase shares in the company at a specific price at a future date. The warrants are tradable in their own right, and their value will go up and down as the price of the shares to which they relate goes up and down. e.g.
- Goodco issues new shares at 50p each. At the same time it gives shareholders warrants entitling them to buy shares at 100p at any time until 1st January 2005.
Warrants have no right to dividends and no voting rights, so their value is tied entirely to the relationship between their exercise price and the share price of the company. If the share price is below the exercise price, the warrants are said to be 'out of the money' and they are worthless. If the share price rises above the exercise price, they are 'in the money' and worth something. e.g.
- Goodco's share price rises to 150p. The intrinsic value of the warrants is now 50p (150p less 100p)
Note that one of the features of warrants is 'gearing'. This means that a small rise in the price of the share price results in a large rise in the value of the warrants, and a fall in the share price has an equally dramatic downward effect on the value of the warrant. e.g.
- Goodco's share price rises 33 per cent from 150p to 200p. The intrinsic value of the warrant rises from 50p to 100p (a 100 per cent rise).
Note that the owner of a warrant does not have to buy the shares. He has a right, not an obligation. Note too that the value of a warrant can quite easily drop to zero (if the exercise price is higher than the share price) and that it will definitely be zero once the time for exercise has passed. So warrants are risky!