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
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