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Learning Objectives

5. Calculate the conversion value of a convertible security. (LO5)

6. Describe warrants and compare them to convertible securities. (LO6)

7. Calculate the intrinsic value and the speculative premium on a warrant. (LO7)

8. Show how convertible securities and warrants affect earnings per share as reported on the income statement. (LO8)

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Warrant:– an option to buy a stated number of shares of

common stock at a specified price over a given time period (a long-term option to buy stock)

– may be attached to another security issue. Investor can usually detach and sell warrants separately

– may be issued “stand-alone”– is highly speculative for the investor, as its value is

dependent on the market movement of the stock– has a large potential for appreciation if the price of the

stock goes up

LO6

Warrants

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Table 19-2Relationships determining warrant prices, October 2011

LO6

Source: www.Canadianwarrants.com

(1) (2) (3) (4) (5) (6) (7)

FirmWarrant

PriceShare Price

Exercise Price

Intrinsic Value

(3) - (4)

Speculative Premium(2) - (5)

Expiry Date

Brick Group (BRK.WT) $1.65 $2.43 $1.00 $1.43 $0.22 May 2014

Crocodile Gold (CRK.WT) 0.175 0.79 2.25 0 0.175 Mar. 2016

CanadianWestern Bank (CWB.WT)

18.72 30.93 14.00 16.93 1.79 Mar. 2014

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Review of Formulas (b)

3. Intrinsic value of a warrant

I = (M - E) x N (19-3)where

I = Intrinsic value of a warrant M = Market value of a common stock E = Exercise price of a warrant N = Number of shares each warrant entitles

the holder to purchase

4. Speculative premium of a warrant

S = W - I (19-4)where

S = Speculative premium W = Warrant price

I = Intrinsic value

LO6