Investments, tenth edition

  Warrants 

    Warrants    are essentially call options issued by a firm. One important difference between 

calls and warrants is that exercise of a warrant requires the firm to issue a new share of 

stock—the total number of shares outstanding increases. Exercise of a call option requires 

only that the writer of the call deliver an already-issued share of stock to discharge the 

obligation. In that case, the number of shares outstanding remains fixed. Also unlike call 

options, warrants result in a cash flow to the firm when the warrant holder pays the exer-

cise price. These differences mean that warrant values will differ somewhat from the val-

ues of call options with identical terms. 

 Like convertible debt, warrant terms may be tailored to meet the needs of the firm. Also 

like convertible debt, warrants generally are protected against stock splits and dividends 

in that the exercise price and the number of warrants held are adjusted to offset the effects 

of the split. 

 Warrants are often issued in conjunction with another security. Bonds, for example, 

may be packaged together with a warrant “sweetener,” frequently a warrant that may be 

sold separately. This is called a  detachable warrant.  

 Issue of warrants and convertible securities creates the potential for an increase in out-

standing shares of stock if exercise occurs. Exercise obviously would affect financial sta-

tistics that are computed on a per-share basis, so annual reports must provide earnings per 

share figures under the assumption that all convertible securities and warrants are exer-

cised. These figures are called  fully diluted earnings per share.   

3

    

  

3

 We should note that the exercise of a convertible bond need not reduce EPS. Diluted EPS will be less than undi-

luted EPS only if interest saved (per share) on the convertible bonds is less than the prior EPS. 

bod61671_ch20_678-721.indd   704

bod61671_ch20_678-721.indd   704

7/25/13   2:50 AM

7/25/13   2:50 AM

Final PDF to printer

---

  C H A P T E R  

2 0

  Options Markets: Introduction 

705

 

The executive and employee stock options that became so popular in the 1990s 

actually were warrants. Some of these grants were huge, with payoffs to top executives in 

excess of $100 million. Yet firms almost uniformly chose not to acknowledge these grants 

as expenses on their income statements until new reporting rules that took effect in 2006 

required such recognition.