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FAQ |
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1. |
What is a Warrant? |
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Warrant
is a type of security trading in the major exchanges.
It entitles the holder a right, but not an obligation,
to purchase or sell the underlying asset (such as common
stock) at a pre-determined period, pre-determined price
(exercise price or strike price) and pre-determined amount
of shares (conversion ratio).
There are two different types of warrants: |
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Equity Warrant (Company Warrant)
Generally speaking equity warrant is a call option
issued by a firm giving the warrant holder a right
to acquire new shares in that firm or any of its
subsidiaries. Usually the exercise price is higher
than the market price at the time of issuance. When
warrant holder exercises this right, the firm has
to issue new shares for them (the total shares outstanding
increases). |
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Derivative Warrant (Covered Warrant)
Derivative warrant generally is issued by investment
bank. It is either a "covered put" or
"covered call" warrant. Most of the derivative
warrants are settled in cash.
Investment banks often use this financial instrument
to manage the risk of their portfolio. On the other
hand, investors can use warrants to hedge their
investment portfolio. |
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2. |
What are the two styles
of warrant? |
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American style warrant - allows its holders
to exercise the right to purchase (call warrant) or sell
(put warrant) the underlying assets on or before the expiry
date.
European style warrant - allows its holders to exercise
the right to purchase (call warrant) or sell (put warrant)
the underlying assets only on the expiry date. |
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3. |
What is warrant premium? |
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It is a measure of how far the price of
the underlying can reach the strike price and it is expressed
as a percentage. When investors expect to hold the position
until maturity, it can be perceived as the break-even
point. |
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4. |
What is time value? |
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Time value is part of the warrant price
that reflects the time remaining on a warrant before expiration. |
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5. |
What is intrinsic value? |
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Intrinsic value is the difference between
the exercise price of the warrant and the value of the
underlying asset.
Call warrants - It has an intrinsic value if the current
price of the underlying asset is higher than the exercise
price.
Put warrant - It has no intrinsic value if the current
price of the underlying asset is higher than the exercise
price.
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6. |
What is "in-the-money"
and "out-of-the money"? |
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The level versus the exercise price and
the current price of the underlying assets: |
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Call Warrant |
Put Warrant |
Intrinsic Value |
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In-the-Money
(ITM) |
The exercise price lower than the
current price of underlying shares |
Exercise price higher than
underlying shares price |
>0 |
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Out-of-the-Money
(OTM) |
The exercise price higher than the
current price of underlying shares |
Exercise price lower than
underlying shares price |
<0 |
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7. |
What are the factors influencing
the value of a warrant? |
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The value of a warrant is influenced by
the following factors:
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Strike price |
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Underlying share price |
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Time before expiration |
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Volatility of the underlying share |
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Market interest rate |
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Dividends to be paid |
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The relationship between the variable and
the value of the warrant:
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Variables |
Change in variable |
Value of call warrant |
Value of put warrant |
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Strike price |
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Underlying share price |
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Time before expiration |
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Volatility of the underlying share |
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Market interest rate |
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Dividends to be paid |
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8. |
What is volatility? |
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It measures the underlying assets' price
movement, which is based on its daily price history over
a specified period. Mathematically, volatility is the
standard deviation of the percentage change in daily price.
There are two kinds of volatility:
Historical Volatility - statistical measurement of price
movements in the past
Implied Volatility - a tool to measure whether warrant
premium is relatively expensive or inexpensive, which
is calculated according to the currently traded warrant
premiums. |
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9. |
What is gearing ratio? |
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Gearing ratio measures the warrant price
in response to one percent price change in the underlying
assets. |
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10.What is physical and
cash settlement? |
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It means that if the warrant expires at
In-the-Money, the warrant issuer will deliver the physical
shares to the holders (majority uses in equity warrant). |
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Most of the derivative warrants issued in
Hong Kong are settled in cash (if warrant expires at In-the-Money).
The amount that the issuer will pay is calculated as follows:
Call Warrant: |
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Put Warrant: |
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Derivatives
