3. Warrants

Warrants are long-term options to buy a stated number of common shares at a specified price that is generally attached to debt issues.

Warrants are attached to debt in hopes of enticing investors to buy lower-coupon, long-term debt, because warrants give investors the chance to profit from the firms upside potential. Warrants are like long-term

call options.

put options.

Sally Rubber Co. is issuing new 19-year bonds with 31 warrants attached to each $1,000 par value bond. Sally Rubber Co. wanted to issue the bonds at par, but a straight-debt bond (without warrants) would have required a 13.00% coupon rate. Instead, the attached warrants allow Sally Rubber Co. to issue the bonds at par with a 7.80% coupon.

Select the straight value of the bond and the value of each warrant in the following table. (Note: Assume that the company pays annual coupons.)

	Value
What is the straight value of the bond?
What is the value of each warrant?

The consensus opinion of analysts is that Sally Rubber Co. undervalued the warrants that it attached to its bonds. According to the analysts, is the coupon rate on Sally Rubber Co.s bonds too high or too low?

Too low

Too high

True or False: Warrants combined with debt instruments that can be removed by the holder and sold in the secondary markets separately are called detachable warrants.

True

False