What Is A Warrant?

What to do

When looking through companies listed on the Mainboard and Catalist exchanges that are run by Singapore Exchange (SGX: S68), we might come across companies that have warrants outstanding. But, what exactly is a warrant and what do we need to know about them?

A warrant is a tradable derivative instrument that gives its holder the right to buy the underlying security at a fixed price within a time period. Warrant holders can exercise the warrant and convert their warrant into common shares of a company.

There are two type of warrants available on the Singapore Exchange; a company warrant and a structured warrant.

A Structured Warrant

A structured warrant is a warrant issued by a bank or other investment entity. The entity in effect is selling the buyer of the warrant an option to purchase the underlying company’s shares at a predetermined price at a later date. The underlying company does not endorse or back this type of warrants.

A Company Warrant

Companies can also issue their own warrants to shareholders. Some companies that have warrants outstanding are Charisma Energy (SGX: 5QT), Rowsley (SGX: A50), Olam International (SGX: O32) and Eu Yan Sang (SGX: E02).

The information that we need to observe for such warrants are:

1)     Expiry date

2)     Strike price

3)     Conversation ratio

Expiry date

For example, Olam International had issued warrants  together with its US$750m bond issue in Jan 2013. The warrants will expire on 28th January 2018. That means that if the warrant is not exercised by the end of January 2018, it will expire worthless.

Strike Price

Those particular warrants of Olam International have a strike price of US$1.25, giving the warrant holder the option to buy Olam shares at US$1.25 apiece regardless of what price the shares might be selling at on the date when the warrant is exercised.

Conversion Ratio

Lastly, the conversation ratio of the warrant is 1 warrant for 1 share. That means that, assuming we own Olam’s warrants, every warrant that we own, entitles us to exercise it for 1 share of the company.

Foolish Takeaway

This is a basic run through of the financial derivative known as a warrant. Some investors might realise that buying warrants can be a cheaper way of investing into a company, but at the same time, the risks involved with investing in warrants is much higher. It is thus better to know our downside risk before investing.