Ch 19 Flashcards
(26 cards)
What is a warrant?
A warrant is a financial instrument issued by a corporation giving the holder the right to purchase common shares at a fixed exercise price before a specified expiration date.
Why do companies issue warrants?
To make bond/preferred share issues more attractive, as part of M&A agreements, or during reorganizations to offer value to shareholders.
What is the intrinsic value of a warrant?
Intrinsic Value = (Market Price of Stock – Exercise Price of Warrant) × Number of Shares purchasable per warrant
What is the speculative premium of a warrant?
Speculative Premium = Warrant Price – Intrinsic Value. It reflects investor optimism about future stock price increases.
How do warrants impact a company’s EPS?
If exercised, they increase outstanding shares and dilute EPS; this is reflected in fully diluted EPS calculations.
How is dilution handled in EPS calculations for warrants?
By assuming warrants are exercised and proceeds are used to repurchase shares at the average market price.
What is a right in corporate finance?
A short-term instrument giving existing shareholders the chance to buy additional shares below market price to avoid dilution.
What is a convertible security?
A bond or preferred share that can be converted into common stock at the holder’s discretion.
Compare the exercise/subscription price of rights, warrants, and convertibles at issue.
A: Rights: below market price; Warrants & Convertibles: above market price.
Which has the shortest time frame: rights, warrants, or convertibles?
Rights (typically short-term, e.g., weeks or a few months).
Do warrants and convertibles cause dilution?
Yes. New shares are issued upon exercise or conversion.
What structural impact does exercising a right have on a company?
Equity increases, debt remains unchanged; no individual wealth effect if rights are used or sold.
What happens to a company’s structure when warrants are exercised?
Equity increases; debt remains unchanged.
How do convertible bonds affect capital structure when converted?
Debt decreases; equity increases—it’s delayed equity financing.
What are derivatives?
Contracts that derive value from an underlying asset, fixing the price for future delivery.
Name the 3 main types of derivatives.
Forwards, Futures, Options
How do forwards and futures differ from options?
A: Forwards and futures are obligations; options give rights without obligation.
What is a forward contract?
A: A customized agreement between two parties to buy/sell an asset at a set future price/date.
What is a futures contract?
A: A standardized contract traded on exchanges, similar to a forward, obligating both parties to transact in the future.
What is a call option?
A: The right to buy an asset at a fixed price within a specific time.
what is a put option?
A: The right to sell an asset at a fixed price within a specific time.
Why do corporations use derivatives?
A: To manage risk (hedging), secure financing, and sometimes for speculative purposes.
How do convertible securities act like options?
They give holders the right to convert debt/preferred shares into common equity
What’s the risk of issuing warrants or convertibles?
Potential dilution of current shareholders’ ownership and earnings per share.
