6. Warrants

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

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

Call options

Put options

Consider the case of The Universal Group. The company issued warrants that allow holders to purchase two shares of the companys common stock at an exercise price of $25.00 per share. These warrants were issued two years ago and are set to expire on October 1 two years from now.

Zoya is an analyst who has been tracking The Universal Groups market performance and its impact on the equity offerings of the company. She submitted a report in January this year stating that the companys warrants were trading at a price of $5.25 each on January 1. The companys common shares were trading at $5.63 per share on the same day. Analysts expect The Universal Group stock price to rise to $35.00 by October 1 two years from now.

Based on your understanding of warrants, complete the following valuations in Zoyas report.

	Value
Formula value of the warrants on January 1 (this year)
Formula value of the warrants on October 1 (two years from now)

Suppose that on October 1 (two years from now) the warrant is trading at a price of $33.00 per warrant. The premium over the formula value on October 1 will be .