Common stock versus warrant investment

Personal Finance ProblemTom Baldwin can invest $4,000

in the common stock or the warrants of Lexington Life Insurance. The common stock is currently selling for $25 per share. Its warrants, which provide for the purchase of 55 shares of common stock at $21 per share, are currently selling for $25.

The stock is expected to rise to a market price of $30 within the next year, so the expected theoretical value of a warrant over the next year is $45.

The expiration date of the warrant is 1 year from the present.

a.If Mr. Baldwin purchases the stock, holds it for 1 year, and then sells it for $30, what is his total gain? (Ignore brokerage fees and taxes.)

b.If Mr. Baldwin purchases the warrants and converts them to common stock in 1 year, what is his total gain if the market price of common shares is actually $30? (Ignore brokerage fees and taxes.)

c.Repeat parts a and b, assuming that the market price of the stock in 1 year is $25.

d. Discuss the two alternatives and the trade-offs associated with them.