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Answer:
Dear
Stasha,
Excellent
question...one that warrants an answer. (Oh dear!
Couldn't resist.)
A
warrant is a security that, for a small price, gives
you the opportunity to buy a stated number of a related
security -- usually common stock -- at a stipulated
price during a specified period of time -- typically
5, 10, 20 years, or, occasionally, perpetually.
The
price at which the warrant can be exercised is fixed
above the current price of the stock at the time the
warrant is issued. For example, when the common stock
is at $10, the warrant might entitle the holder to
buy one share at $15.
Why
companies issue warrants
Companies
typically sell warrants as sweeteners to enhance the
marketability of a new issue of its common or preferred
stock or as part of a new bond issue -- in all three
instances, steps taken to raise money for the company.
Warrants sometimes are issued in place of cash or
stock dividends to stockholders of record.
In
general, think of them as an incentive move on the
part of the company.
Listing
After
a warrant is issued, it trades on either the New York
or American stock exchanges or over the counter. It
is listed in the stock tables and trades like other
investments. You can quickly recognize a warrant because
it will have the initials wt next to the name of the
stock.
Their
pros & cons
A
warrant, like an option, provides a way to calculate
on making money on the future price of a stock. Investors
buy warrants when they believe a stock will be moving
up in price. And that dollar investment is less than
if you purchase shares of the stock outright.
For
example, you might pay $1 per share for the right
to buy Company ABC at $10 within five years. If the
price goes up to $15 and you exercise your warrant,
you'll save $4 on every share you buy. You can then
sell the shares at the new, higher price and make
a profit.
$15
- ($10 + $1) = $4, or $400 on 100 shares
On
the other hand, if the price of the stock when the
warrant expires is below the set price -- in our example
that would be below $10 in five years -- the warrant
is useless. In other words, on its expiration date,
a warrant loses all its trading value.
Another
negative -- as a warrant holder you do not have equity
or voting rights nor do you receive dividends.
Trading
activity
The
price of the warrant is directly affected by the trading
volatility of the underlying stock.
The
two securities, in fact, tend to move somewhat in
parallel directions. Therefore, an advance in the
price of the stock creates a higher percentage gain
for the warrant than for the stock.
Warrants
vs. options
The
key advantage warrants have over options is that they
run a much longer length of time. The longest option
lasts nine months. Warrants, however, run for years
and some in perpetuity, which gives investors a chance
to speculate on a company over the long term at a
relatively low cost. This time frame also makes warrants
less risky than options.
Other
thoughts
You
should buy only warrants of a common stock that you
would want in your portfolio.
The
best profits come from warrants associated with companies
that have potential for strong upward movement in
price due to significant earnings gains and/or the
announcement of important new products or services.
Good
luck!
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