Characteristics, Uses and Taxation of Investments - Warrants and Rights


b. Warrants and Rights - warrant and rights enable investors to benefit from the value of the underlying stock upon which they are based but in different ways.

  1. Warrants - these are certificates that derive their value from the underlying stock upon which they are based. Owners have the right to purchase the underlying shares at a price specified in the contract. Unlike options, the party required to deliver shares upon exercise is the issuer, rather than the writer; typically warrants are valid for five years, though some are perpetual. Usually an add-on or sweetener to an issuer's fixed income securities, warrants are attractive to the issuer as they afford it the ability to issue either preferred stock or bonds at a lower interest rate that it would otherwise have to for a similar security. Their value to the holder is the ability to participate in the potential appreciation of the issuer's equity securities at a considerably lower cost and maintain the downside protection of the bond.
  2. Rights - these are available to existing shareholders of a stock to enable them to maintain proportionate ownership in it by being able to buy newly issued shares before the issuing company offers them to the public. The rights allow shareholders to buy the shares below the current market price. Rights are valued separately and trade in the secondary market during the subscription period. Holders can exercise the rights and purchase the stock; sell them or let them expire. Their value is a function of that of the underlying security.
Derivative/Feature Warrant Right Listed Options
Marketability Trade actively in the secondary market. Trade actively in the secondary market. Trade actively in the secondary market.
Cost Less expensive than the underlying equity security upon which it is based. The warrants may be attached to a fixed income issue as a sweetener. Inexpensive relative to the underlying upon whose value theirs is based, rights allow for a discounted purchase of the issuer\'s shares. Valuation is a function of volatility of the underlying investment upon which it is based; the time left until expiration, the level of interest rates and the extent to which the option is either in- or out-of-the-money.
Potential Risks Warrants may expire unexercised. Additionally, they mirror the risks of the underlying stock and could lose a substantial portion of their value. Like their value, their risk is based upon that of the issuer and could lose a substantial portion of their value as a result. Options share in the risk of the underlying security and can magnify losses due to the feature of leverage. Loss is unlimited only with naked calls and short puts.
Term Long term up to five years. Some issues are perpetual. Short term, usually thirty to forty five days. Nine months, LEAPS® have up to thirty nine months.
How Offered Offered as a sweetener for another security to which they are attached, they also trade separately. Offered to existing shareholders, they also trade in the secondary market, but for a much shorter time. Trade separately on an exchange.
Offering Terms upon issuance
Exercise price is higher than the market price (out-of-the-money). Exercise price is lower than the market price (in-the-money). The exercise price may vary relative to that of the underlying security.
Underlying Instruments Common stock Common stock Common stock, bonds, interest rates, stock indices and foreign currencies.
Tangible Assets
Related Articles
  1. Investing

    Build a Retirement Portfolio for a Different World

    When it comes to retirement rules of thumb, the financial industry is experiencing new guidelines and the new rules for navigating retirement.
  2. Trading Strategies

    Only Take a Trade If It Passes This 5-Step Test

    Not every moment is a good trading opportunity. Put each trade through this five-step test, so you're trading only at the best profit potential times.
  3. Mutual Funds & ETFs

    ETF Analysis: United States 12 Month Oil

    Find out more information about the United States 12 Month Oil ETF, and explore detailed analysis of the characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Ultra Nasdaq Biotechnology

    Find out information about the ProShares Ultra Nasdaq Biotechnology exchange-traded fund, and learn detailed analysis of its characteristics and suitability.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Floating Rate Bond

    Explore detailed analysis and information of the iShares Floating Rate Bond ETF, and learn how to use this ETF as a defense against rising interest rates.
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  7. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  8. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  9. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Value

    Find out about the Vanguard Small-Cap Value ETF, and explore detailed analysis of its characteristics, suitability, recommendations and historical statistics.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!