1. finlogIQ
Knowledge for financial IQ
STRICTLY PRIVATE AND CONFIDENTIAL
Chapter 9
Warrants and Other Investment Products
August 2012

2. Chapter summary and outline
This chapter outlines the features of various types of structured
warrants, including company warrants, exotic options and other
products.
Chapter outline:
• Company warrants
• Structured warrants
• Exotic options/warrant structures and features
• Other investment products
• Market outlook and products
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3. Introduction
• Warrant is a derivative that gives the investor an option to buy or sell a
stated number of shares of an underlying instrument at a specified price
(exercise or strike price) within a specified time period.
– Not margined and therefore not subject to margin calls
– Traded on the SGX-Securities Trading Ltd
– Warrant holders do not receive nor pay any dividend income or cash distributions
even if the underlying instrument pays a dividend or cash distribution.
• Structured products are derivatives issued by third parties which are not the
same entity as the issuer of its underlying security.
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4. Company Warrants
• Is a long-dated call option as its maturity is typically 3-5 years
– Whereas options and structured warrants have expiration dates of less than 1
year.
• Generally issued by listed companies as a “sweetener” attached to an
offering of bonds or rights issues for shares.
– Allows the issuer to obtain a lower interest rate on its bond issue, and hence
lower its financing cost.
• Detachable from the host instrument and may be listed and traded
separately.
– Are “American-style” options
– May be exercised at any time during the lifetime of the warrant.
• When these warrants are exercised, the issuer will issue the new shares.
– Result in a dilution of the listed company’s earnings.
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5. Structured Warrants
• Formerly known as covered warrants.
• Issued by third party financial institutions based on various underlying
instruments like single stocks, stock indices, investment funds and
commodities.
• Different types of structured warrants are designed for different investment
objectives and risk profiles of investors.
• Call warrant gives the holder a right to buy the underlying asset while a put
warrant gives the holder a right to sell the underlying asset at a
predetermined price, on or before the expiry date, depending on the
exercise style of the warrant.
• Structured warrants in Singapore are “European-style” options and Only be
exercised on the expiry date
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6. Common Features and Terms of a Warrant
Issue
• Conversion ratio (n)
– Number of warrants needed to be exercised to buy or sell one unit
• Exercise or strike price (X)
– Price at which the holder is able to buy or sell
• Expiry Date
• Issue Price
– Price at which the structured warrant is sold by the issuer
• Physical Delivery or Cash Settlement
– Physical delivery of shares or by cash.
– Upon exercise of the warrant, depending on whether the warrant is a call or put,
the holder can expect to deliver to, or receive from, the issuer the underlying
share (or cash).
– Settlement style is made known when the warrant is issued.
– Structured warrants listed on the SGX are settled in cash.
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7. Common Features and Terms of a Warrant
Issue - 2
• Size of Issue
• Gearing
– Usually priced at a fraction of the share price, offers benefit of gearing
– For e.g. a small percentage gain in the underlying share price may lead to large
percentage gain in the value of the call warrants
– A fall in the price of the underlying share may result in large percentage loss in
the value of the warrants
– Note: A certain percentage change in the price of the underlying results in a
larger percentage change in the warrant.
– But, when company’s share price remains unchanged, the warrant price declines
nonetheless, due to time value decay of the warrant.
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8. Common Features and Terms of a Warrant
Issue - 3
• Delta
– The rate at which its price changes with respect to changes in the price of the
underlying asset.
– Call deltas are always positive
– Put deltas are always negative
– At-the-money warrants have a delta of around 0.5.
– One cent change in the value of the underlying asset results in 0.5 cent change
in the value of the warrant.
– Options which are deeply in-the-money have a delta of close to 1.
– Delta = n x δWP/δS
– Important when deciding on the strike price of a warrant.
– When expecting a small move in the price of the underlying asset should buy
warrants which are at-the-money or slightly in-the-money while investors
expecting a large move can buy out-of-the-money warrants.
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9. Common Features and Terms of a Warrant
Issue - 2
• Effective Gearing
– Effective gearing = delta x gearing
– A 1% increase in the underlying price results in a 5.25% increase in the warrant
price illustrating its effective (or actual) gearing of 5.25 times.
– Call warrants with high strike prices provide more gearing But not appropriate if
only a small price move is expected.
– The strike price chosen should be between the current share price and the
expected share price.
– Maturity of the warrants should be carefully chosen to avoid excessive time
decay loss.
• Implied Volatility:
− Volatility implicit in the market price of the warrant
− Measure of risk
− Higher the volatility of the underlying shares, the more expensive a warrant is
– Implied Volatility = f(share price, warrant price, strike price, maturity, interest rate
and dividend yield)
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10. Interpreting the Trading Name of a Structured
Warrant
Example: ABC XYZ eCW120228
• Underlying instrument (“ABC”)
• Issuer (“XYZ”)
• Exercise style (“e”)
• Type of warrant (“CW”)
• Expiration date (“120228”)
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11. Warrant Valuation
Intrinsic Value (IV)
• Difference between the exercise price of a warrant and the market price of
the underlying asset.
• Only in-the-money warrants have intrinsic value.
• Call Warrant
– IV = MAX{0, (S - X)/n}
• Put Warrant
– IV = MAX{0, (X - S)/n}
Conversion Price (CP)
• Total price which the investor pays by converting the warrants into the
underlying security, and is also known as the breakeven price.
• Call Warrant
– CP = X + nWP
• Put Warrant
– CP = X – nWP
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12. Warrant Valuation - 2
Premium
• The difference between the warrant price and intrinsic value
• Different from the one used in options, where the premium is actually the
price of the option
• Largely the time value of the warrant
• Call Warrant Premium ($) = nWP + X – S
• Put Warrant Premium ($) = nWP - X + S
• Premium is usually expressed as a percentage of the underlying share
price.
– Percentage by which the underlying share price needs to have moved at maturity
for the investor to break even.
• Call Warrant
– Premium (%) = [(nWP + X - S)/ S] x 100
• Put Warrant
– Premium (%) = [(nWP - X + S)/ S] x 100
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13. Warrant Valuation - 3
Premium
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14. Role of the Warrants Issuer
• Listing document spells out the contractual rights and obligations of both the
warrants issuer and warrant holder
• Issuer will have the obligation to deliver the underlying instrument and pay
the exercise price if the holder exercises a call or receive the underlying
instrument and pay the exercise price if the holder exercises a put.
• Most, if not all, structured warrants in Singapore settle in cash instead of
delivery of the underlying.
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15. Market-Making of Structured Warrants
• Warrant issuers who commit to make a market for the structured warrants
they issued do not need to comply with the minimum placement and holder
size requirement for listed equity securities, and the minimum issue size
requirement is reduced from SGD 5 million to SGD 2 million.
• Listing document states whether Warrant issuer has committed to make a
market in the structured warrants.
• Designated market-maker :
– appointed by the warrants issuer is obligated to provide competitive bid and offer
prices for the structured warrants.
– committed to make a market for their structured warrants during the normal
trading hours.
– The maximum spread (the difference between a DMM's bid and offer quotes)
and minimum lot size that DMMs are required to provide on the structured
warrants are set out by the structured warrants issuers in the listing documents
of the respective structured warrants.
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16. Settlement Issues
Physical Settlement
• To exercise a call warrant holder will need to submit an exercise notice with
the cash payment (based on the exercise price) to the warrant agent.
• Warrant agent will then inform the Central Depository Pte Ltd (“CDP”) and
the issuer on this
• CDP will credit the account of the holder with the underlying securities and
debit the account of the issuer with the same.
• For Put warrant, CDP will debit the account of the holder for underlying
securities and credit the account of the issuer for the same.
• Exercise expenses are payable by the holder to the warrant agent
Cash Settlement
• Most structured warrants are automatically exercised and settled in cash on
the expiration date.
• Proceeds are calculated based on the difference between the market price
of the underlying and the exercise price.
• Call Warrant - Cash settlement per warrant = (S – X)/n
• Put Warrant - Cash settlement per warrant = (X – S)/n
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17. Settlement Issues - 3
Call Warrant Put Warrant
Scenario When underlying share price When underlying share price
rises above the warrant fall below the warrant exercise
exercise price price
Gain from Difference between the current Difference between the
a) Exercising share price and the warrant warrant exercise price and the
the warrant exercise price current share price
b) Selling the Difference between the Difference between the
warrant prevailing warrant price and prevailing warrant price and
the warrant price paid by the the warrant price paid by the
investor. investor.
Warrant price would have Warrant price would have
increased with the rise in the increased with the fall in the
share price share price
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18. Settlement Issues - 4
• Asian option/warrant is a path-dependent contract where the payoff is
calculated from the mean of the values at certain dates.
– Path-dependent => when the payoff does not only depend on the terminal price
of the underlying asset at maturity, but also on the path, the values it has taken
on to reach its final value.
• Structured warrants in Singapore have the Asian style of expiry settlement.
Where:
– Last trading day of a structured warrant is different from its expiry day.
– Last trading day in the “Ready” and “Unit Share” markets is at least 3 business
days before its expiry date.
– Investors can only trade the structured warrant on or before the last trading day.
– The settlement price is based on the arithmetic average of the official closing
price of the underlying for 5 market days prior to expiration date.
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19. Corporate Action Adjustments for Structured
Warrants
• Structured warrants are subject to adjustments to take into account any
corporate action arising from the underlying stock.
• Corporate actions such as rights issue, bonus issue, stock splits, special
dividends or consolidation may lead to a diluting or concentrative effect on
the theoretical value of the underlying stock.
• Adjustments to the conversion entitlement, the exercise price or other
variables of the structured warrants effective on the ex-date of the corporate
action.
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20. Exotic Options/ Warrant Structures and
Features
Index Warrants
• Warrants are settled on exercise via a cash payment.
– Calculated by multiplying the difference between the exercise level (strike price)
and the current index-level or settlement index level by a multiplier to convert the
index points into cash.
• Adjustments are normally not required on the warrant terms for corporate
actions involving the component stocks of the index upon which the
structured warrants is based.
– This is because the underlying index will have already adjusted itself to take into
account such corporate actions.
Currency Translated Warrants
• Settlement and trading currency (home currency of the investor) is different
from the underlying’s currency.
• E.g. Structured warrant on the Hang Seng Index traded in Singapore
– Underlying currency which is the reference currency is in HKD.
– The settlement currency is in SGD
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21. Exotic Options/ Warrant Structures and
Features
Basket Warrants
• Underlying is a basket of (pre-defined) shares
• Likely to be based on a particular industry (e.g. technology, bio-tech, banks)
• Maybe settled with a physical delivery of the basket components or via cash
Yield Enhanced Securities/Discount Certificates
• Provides yield enhancement to the investor
• Cash settlement amount is linked to the market price of the underlying asset
• At maturity
– if the closing price of the underlying on expiration is at or above the exercise
price, the holder will receive a cash settlement equal to the exercise price.
– If the closing price is below the exercise price, then the holder will receive a cash
settlement equal to the value of the underlying on the expiration date.
• Cap strike or exercise price represents the maximum price achievable with
a discount certificate.
• Potential upside exposure is sacrificed in return for the ability to purchase
the underlying asset at a discount to the market price.
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22. Other Investment Products
Global Depository Receipts (“GDRs”)
• Allow for non-local equities to be traded on the local securities exchange.
– Provide local investors an avenue to invest and trade in shares of non-locally
listed companies.
• GDRs are negotiable certificates of ownership
– Represent a claim to a certain number of foreign shares
• Issued by a financial institution that in turn would purchase an inventory of
the underlying equity.
• These institutions collect dividends net of foreign withholding taxes and in
turn pay the dividends to the GDR holders.
• GDRs allow for an issuer who is already listed on its home exchange to
raise funds and list locally.
• Currently, GDR listing requirements in Singapore are less stringent
compared to primary and secondary listings where retail participation is
allowed.
– Hence, offered only to institutional and accredited investors.
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23. Other Investment Products - 2
Convertible Bonds
• Fixed income instruments have embedded call options on the underlying
equity securities
• Right to covert the bond for a specified number of shares of the same issuer
– A variation to this is an exchangeable bond, where the holder has the right to
exchange the bond for the equity securities of another issuer – in many cases a
related company of the bond issuer
• Conversion value (the value as if converted immediately)
Conversion value = market price of share x conversion ratio
• The minimum value of the convertible bond is the greater of
– its conversion value;
– its value without the conversion option, i.e. the value of an equivalent
unconvertible bond. This is known as the straight value.
• The effective price that an investor pays for shares if the investor purchases
the convertible bond and converts it into shares is called the market
conversion price or conversion parity price.
Market conversion price = market price of convertible bond / conversion ratio
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24. Market outlook and products
• Neutral: yield enhanced security, range accrual note.
• Bullish: call warrant purchase, ADR/GDR, convertible bond (near-term
outlook is uncertain or bearish), index linked note.
• Bearish: put warrant purchase.
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