Warrants are securities issued by a company that give an investor the option to buy a certain number of stocks at a fixed price up to a set future date. The stock purchase price is higher than the current price of stock when the warrant is issued. A warrant, therefore, is only valuable if the price of the company’s stock rises to more than the specified price. Warrants are commonly issued by companies in conjunction with the sale of bonds or preferred stock to make the purchase more appealing.
For an example, suppose a company with a current stock price of $10 US Dollars (USD) issues a warrant to an investor giving her the option to buy stock in the company at $15 USD a share for the next five years. If the five years go by and the market price of the company’s stock never exceeds $15 USD a share, the warrant is useless. Conversely, if two years after it is issued the stock goes up to $20 USD a share, the investor can buy the stock at $15 USD a share and immediately have a profit of $5 USD per share.
Warrants can be traded as well as exercised. Some can only be exercised on specific dates, such as the anniversary of the issue date. It is important to check the terms before trying to use it.
An investor who owns a warrant can sell it to a third party at any time. There is no fixed rate on the sale of warrants. The holder and the third party decide on an agreeable price for the sale. Warrants that are close to the current stock price and those with longer periods before they must be exercised usually fetch the highest prices.
While a warrant gives the holder the right to purchase stock, it is not the same as owning stock in the company. A warrant holder does not benefit from dividends or stock splits and cannot vote on company policy or board of directors. Only after the warrant is exercised can the holder take advantage of shareholder benefits.
Warrants are often confused with call options. A call option is similar in that it too allows an investor to purchase underlying stock at a certain price for a set time period. Unlike call options, warrants are issued and backed by the company. Additionally, the terms of a call option are typically measured in a matter of months while warrants tend to have a lifetime of multiple years.
