Warrant (Finance) Definition
A warrant is defined as permit that investors or employees have to buy or sell a number of ownership interest in the company at a strike price at a period in time. Most investors are attracted to warrants, this is because it gives them the right to buy or sell a security (stock or bond) at a certain price, which is usually the strike price before expiration.
A warrant is not an obligation, it is a contractual right. Whoever holds can sell or purchase equity in the underlying company at a particular price. The price at which the underlying security can be exchanged (bought or sold) is the exercise price or strike price.
A Little More on What are Warrants
An underlying company issues warrants to its investors or employees so that they can exchange stock at exercise price before the expiration of time. However, warrants in the United States are slightly different from those in Europe. For instance, an American warrant can be exercised by its holder at any time prior to the expiration date but a holder of an European warrant must exercise this right on the expiration date.
- Note: warrants last for several years unlike options that last for shorter times like weeks or months.
Warrants are issued for new stocks or equity, as against granting warrants for already-used or old stock.
- Note: under options, external parties who are not affiliated with the underlying company can issue this, such as investors or traders.
In this case, when a warrant right holder exercises the right, new stock must be issued. Due to the fact that the issuance of new stock or shares can cause a reduction in the value of a shareholding, the issuance of warrants in this case are tagged dilutive.
- Note: Options deal with outstanding or already-used shares that are not dilutive.
In addition, while options are publicly traded, warrants are mostly issued and traded in close-up transactions, warrants are not often publicly traded.
There are many types of warrants, the common types of warrants include;
- Warrants – this is the plain and common warrant that an underlying company issues to investors or employees.
- Detachable Warrants- it gives rights to investors to trade some bonds separately from the underlying bonds prior to the expiration date.
- Wedded Warrants – They cannot be separated from the co-issued bond.
- Covered warrants – financial institutions issue this type of warrant, it allows investors trade financial instruments. They are broader than company-issued warrants.
- Naked warrants – they are not attached to any bond.
- Trading Warrants – they are publicly traded and are more flexible.
References for Warrants
Academic Research on Financial Warrant
Rational theory of warrant pricing, Samuelson, P. A. (1965). IMR; Industrial Management Review (pre-1986), 6(2), 13.
Arrest without a Warrant, Wilgus, H. L. (1923). Mich. L. Rev., 22, 541.
Warrant valuation and exercise strategy, Emanuel, D. C. (1983). Journal of Financial Economics, 12(2), 211-235.
Robustness of option-like warrant valuation, Schulz, G. U., & Trautmann, S. (1994). Journal of Banking & Finance, 18(5), 841-859.
A complete model of warrant pricing that maximizes utility, Samuelson, P., & Merton, R. C. (1969). IMR; Industrial Management Review (pre-1986), 10(2), 17.
Equilibrium warrant pricing models and accounting for executive stock options, Noreen, E., & Wolfson, M. (1981). Journal of Accounting Research, 384-398.
Warrant exercise and bond conversion in competitive markets, Constantinides, G. M. (1984). Journal of Financial Economics, 13(3), 371-397.
Activity-Based Costing: Does it Warrant Inclusion in a Guide to the Project Management Body of Knowledge (PMBOK® Guide)?, Kinsella, S. M. (2002). Project Management Journal, 33(2), 49-56.
Warrant exercise, dividends, and reinvestment policy, Spatt, C. S., & Sterbenz, F. P. (1988). The Journal of Finance, 43(2), 493-506.
A model of warrant pricing in a dynamic market, Chen, A. H. (1970). The Journal of Finance, 25(5), 1041-1059.
Mutual recognition in European judicial cooperation: A step too far too soon? Case study—the European arrest warrant, Leaf, S. A. A. M. (2004). European Law Journal, 10(2), 200-217.
Warrant pricing: jump-diffusion vs. Black-Scholes, Kremer, J. W., & Roenfeldt, R. L. (1993). Journal of financial and Quantitative Analysis, 28(2), 255-272.