Warrant (finance)
|
|
- For other uses of the term Warrant, see Warrant
A warrant is the right — but not the obligation — to buy or sell a certain quantity of an underlying instrument at an agreed-upon price. The right to buy the underlying instrument is referred to as a call warrant; the right to sell it is known as a put warrant. In this way a warrant is very similar to an option. The difference is primarily that the length of time available to exercise a warrant is much longer than most option contracts. Most warrants have 5-10 years before they must be exercised or expire worthless. In addition, when a warrant is exercised, a new share of stock is created, whereas when an option is exercised, the owner of the option receives an existing share that is delivered by a counterparty (except in the case of employee stock options, where new shares are created and issued by the company upon exercise).
There are two types of warrants: "traditional" warrants and so-called naked warrants.
Traditional warrants are issued in conjunction with a bond (known as a warrant-linked bond), and represent the right to acquire shares in the entity issuing the bond. In other words, the writer of a traditional warrant is also the issuer of the underlying instrument. Warrants are issued in this way as a 'sweetener' to make the bond issue more attractive, and to reduce the interest rate that must be offered in order to sell the bond issue.
Naked warrants are issued without an accompanying bond, and like traditional warrants, are traded on the stock exchange. They are typically issued by banks and securities houses. The writer of a naked warrant need not be the issuer of the underlying instrument. A naked warrant is essentially an option with a very long time to expiry. Therefore an employee stock option is also equivalent to a warrant.
Also, when a government agency issues checks which they are unable to pay (due to lack of money) but are redeemable at some point in the future, usually with interest, these are also called warrants. A few years ago, when the State of California had a budget crisis due to a disagreement between the governor and the legislature, the state treasurer was forced to issue warrants paying 18% interest in lieu of being able to pay the state's bills with real money. The state had not had to rely on this practice since before the Depression of the 1930s Many places were accepting them at face value because of the interest provision. It was interesting that during this period the Controller of Los Angeles County was buying state warrants to invest the county's surplus funds because the county, on the other hand, actually had money and the interest rate was better than any bank would pay.