Warrants

In recent years, firms have started looking at equity alternatives to common stock. One alternative used successfully by the Japanese companies in the late 1980s involved warrants, where the holders received the right to buy shares in the company at a fixed price in return for paying for the warrants up front. Since their value is derived from the price of the underlying common stock, warrants have to be treated as another form of equity.

Why might a firm use warrants rather than common stock to raise equity? We can think of several reasons. First, warrants are priced based upon the implied volatility assigned to the underlying stock; the greater the volatility, the greater the value. To the degree that the market overestimates how risky a firm is, the firm may gain by using warrants and optionlike securities. Second, warrants, by themselves, create no financial obligations at the time of the issue. Consequently, issuing warrants is a good way for a high growth firm to raise funds, especially when current cash flows are low or negative. Third, for financial officers who are sensitive to the dilution created by issuing common stock, warrants seem to provide the best of both worlds — they do not create any new additional shares currently, while they raise equity investment funds for current use.

Warrants: A warrant is a security issued by a company that provides the holder with the right to buy a share of stock in the company at a fixed price during the life of the warrant.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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