Convertible bonds and warrants are like call options. However, there are some important differences:

a. Warrants and convertible securities are issued by corporations. Call options are traded between individual investors.

i. Warrants are usually issued privately and are combined with a bond. In most cases the warrants can be detached immediately after the issue. In some cases, warrants are issued with preferred stock, with common stock, or in executive compensation programs.

ii. Convertibles are usually bonds that can be converted into common stock.

iii. Call options are sold separately by individual investors (called writers of call options).

b. Warrants and call options are exercised for cash. The holder of a warrant gives the company cash and receives new shares of the company’s stock. The holder of a call option gives another individual cash in exchange for shares of stock. When someone converts a bond, it is exchanged for common stock. As a consequence, bonds with warrants and convertible bonds have different effects on corporate cash fl ow and capital structure.

c. Warrants and convertibles cause dilution to the existing shareholders. When warrants are exercised and convertible bonds converted, the company must issue new shares of common stock.

The percentage ownership of the existing shareholders will decline. New shares are not issued when call options are exercised.

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