What it is:
A warrant premium is the percentage difference between theof a security and the price an investor pays for that security when buying and exercising a .
The formula for thepremium is:
Premium = 100 x [( Price + Exercise Price – Current Share Price) / Current Share Price]
How it works/Example:
For example, if Company XYZ issued $100 million ofwith warrants attached, each might get a $1,000 face-value and the right to purchase 100 of Company XYZ at, say, $20 per share over the next five years. The price at which a warrant holder can purchase the is called the exercise price or . In our example, the exercise price is $20, which is, say, 15% higher than what Company XYZ was trading at when the were issued. The warrant's exercise price often rises according to a schedule as the matures.
Let's say theis currently trading at $10 per share right now. Using this information and the formula above, we can calculate the warrant premium:
Warrant Premium = 100 x [($0 + $20 - $10) / $10] = 100%
Why it matters:
Warrants tend to trade above their minimum value. For example, consider a warrant to purchase 100
It is important to , however, that if the warrants still had long to go before their expiration date, investors might speculate that the price of Company XYZ could go even higher than $100 a share. This speculation, accompanied by the extra time for the to rise further, is why a warrant with a minimum value of $80 could easily trade above $80. But as the warrant gets closer to expiring (and the chances of the price rising in time to further increase profits get smaller), that premium would shrink until it equaled the minimum value of the warrant (which could be zero if the price falls to below $20 rather than rising above $100).
This opportunity to participate in the of another security gives investors a little diversification and thus is a way to mitigate risk. As a result, companies often and preferred stock with warrants attached as a way to enhance the demand and marketability of the . This in turn lowers the for the .