What is a Warrant?

A warrant is a type of derivative security that grants the holder the right, but not the obligation, to buy or sell an underlying security at a predetermined price before a specified expiration date. When a company issues warrants, it sets specific terms and conditions for exercising these rights. For instance, US companies typically issue American-style warrants that can be exercised anytime before expiration, while European companies often issue European-style warrants, exercisable only on the expiration date.

Warrants vs. Options

While warrants and options share similarities, there are key distinctions. Firstly, warrants have a dilutive effect on a company’s shares as the exercise of warrants requires the issuance of new shares. Options, on the other hand, are traded between investors and do not directly impact the company’s share count. Secondly, warrants are issued by the company, whereas options are created by investors trading existing shares.

Why do Companies Issue Warrants?

Companies often attach warrants to debt securities to make them more attractive to investors, such as by offering lower interest rates. These warrants are usually distributed to existing shareholders without any additional cost and can be traded separately. By issuing warrants, companies can potentially raise additional capital when investors exercise their options to convert the warrants into shares.

Case Study: Warrants in Action

Warrants are often seen as a useful indicator of a stock’s future performance. When a company issues warrants, investors have a period of time to decide whether to exercise their option to purchase the underlying stock at a predetermined price. 

For example, consider Company A. 

Chart 1 shows the company’s stock price over a period, demonstrating a downward trend.