frm_student_1
New Member
Hi David,
I was wondering if I could get your help better understanding warrants. I have a few questions below. I have tried searching the internet but haven't stumbled on a satisfactory response yet:
Before I begin, let me say that I have already read an earlier thread on warrants:
https://forum.bionicturtle.com/threads/warrants-dilusion.6797/#post-23199
As for my questions:
Q1) I wanted to confirm that warrants affect stock price both at the a) time of the issue (time = O) and b) upon exercise (assuming European warrants, time = T where T is the maturity time of warrants).
Q2) Confirm, with regard to calculating the impact on stock price at the time of issue: it is determined by the following steps:
Q3) Confirm, with regard to calculating the impact on stock price after exercise (a phenomenon known as dilution): it is determined by the following steps:
Q4) I don't know if I quite understand the circular pattern in Q2 above. In particular, stock price S(beforeO) determines regular call price which in turn determines warrant price. Now as the result of issuing warrants the stock price at time O would go down i.e. S(afterO) < S(beforeO). Now my question is wouldn't the fall in stock price at time O trigger the recalculation of a regular call price at time O. If it does then does it also trigger a recalculation of warrant call price?...It seems like we could go on in circles forever, please explain!
Q5) The Bionic Turtle notes for Hull suggest an alternative method for calculating warrant price at time O i.e. rather than following the steps outlined in Q2 above, the BT suggests using the BSM formula for call options for valuing warrants however with some verifications. I need some help understanding these variations:
I was wondering if I could get your help better understanding warrants. I have a few questions below. I have tried searching the internet but haven't stumbled on a satisfactory response yet:
Before I begin, let me say that I have already read an earlier thread on warrants:
https://forum.bionicturtle.com/threads/warrants-dilusion.6797/#post-23199
As for my questions:
Q1) I wanted to confirm that warrants affect stock price both at the a) time of the issue (time = O) and b) upon exercise (assuming European warrants, time = T where T is the maturity time of warrants).
Q2) Confirm, with regard to calculating the impact on stock price at the time of issue: it is determined by the following steps:
Step 1: Determine the price of a regular call using the Black-Scholes formula
Step 2: Determine price of warrant where N - outstanding shares and and M - warrants issued
Step 2: Determine price of warrant where N - outstanding shares and and M - warrants issued
price (or value) of a warrant is (N/N+M)* price of regular call
Step 3: Calculate total cost of warrant issue. total cost = M*price of warrant
Step 4: Assuming stock price at time O before warrant issue is S(before), calculate stock price S(after) at time O after warrant issue:S(afterO) = [ N*S(beforeO) - total cost of warrant]/ N
Q3) Confirm, with regard to calculating the impact on stock price after exercise (a phenomenon known as dilution): it is determined by the following steps:
Step 1: Determine total equity: (S(beforeT) is stock price at time T before exercise and K is strike price)
total equity = S(beforeT)*N + K*M
Step 2: Determine stock price after warrant exerciseS(afterO) = [total equity]/ [N+M]
Q4) I don't know if I quite understand the circular pattern in Q2 above. In particular, stock price S(beforeO) determines regular call price which in turn determines warrant price. Now as the result of issuing warrants the stock price at time O would go down i.e. S(afterO) < S(beforeO). Now my question is wouldn't the fall in stock price at time O trigger the recalculation of a regular call price at time O. If it does then does it also trigger a recalculation of warrant call price?...It seems like we could go on in circles forever, please explain!
Q5) The Bionic Turtle notes for Hull suggest an alternative method for calculating warrant price at time O i.e. rather than following the steps outlined in Q2 above, the BT suggests using the BSM formula for call options for valuing warrants however with some verifications. I need some help understanding these variations:
Variation #1: S(O) used in the BSM formula is said to be the adjusted stock price. Is this the stock price S(afterO) above?
Variation #2: volatility is calculated on equity rather than stock price. Would this different volatility be given in the exam question?
Variation #3: A haircut of N/(N+M) is applied to the calculated value. Does this mean that as a result of incorporating the 1st two variations the price we get from BSM is that of a regular call (after the announcement of a warrant)? Consequently, similar to in Q2, by applying the haircut we get the value of the warrant?
Variation #2: volatility is calculated on equity rather than stock price. Would this different volatility be given in the exam question?
Variation #3: A haircut of N/(N+M) is applied to the calculated value. Does this mean that as a result of incorporating the 1st two variations the price we get from BSM is that of a regular call (after the announcement of a warrant)? Consequently, similar to in Q2, by applying the haircut we get the value of the warrant?
