In financial management, we decide how much money when and how we can use and invest. In simple terms, financial management teaches us how to manage monetary resources efficiently.
There are majorly three types of finance: Personal finance, Corporate finance, and Public finance. Personal finance is the management of finance on an individual level or as a family unit. In which an individual or a family unit manages the budget, savings, and spends the money resources after considering the various financial risks and future events. Now, we will learn about various components which come under Personal finance. One of them is “WARRANT“.
What is Warrant?
A warrant is a type of security that gives the holder the right, but not the obligation, to buy or sell an underlying security at a specified price within a certain period. Warrants are often issued by companies as a way to raise capital, and they are typically traded on exchanges. In simple terms, Warrant is a contract that gives the right to buy or sell a company’s stock at a fixed price for a particular period. Warrants work similarly to options. The holder of a warrant has the right, but not the obligation, to buy or sell the underlying security at a specified price within a certain period. If the holder exercises their right, they will buy or sell the underlying security at the strike price. If the market price of the underlying security is above the strike price, the holder will make a profit.
Who and Why Issues Warrant?
Companies’ issues warrant mainly for raising funds or capital. It receives capital on the issuance of a warrant and whenever stock is purchased by using the warrant again. Warrants are often issued by companies as a way to raise capital, and they are usually attached to another security, such as a bond or stock. For example, a company might issue warrants that entitle the holder to buy shares of the company’s stock at a set price within five years.
Three Important Factors of Warrant:
- Exercise Price: It is the amount in which you can buy and sell the stocks. It’s also known as STRIKE PRICE. If the current market price of the security is below the strike price, the warrant is said to be “out of the money.”
- Warrant Price: It is the price you pay for the warrant.
- Expiration Date: This is the period within which you can buy or sell the stocks. They aren’t worth it after the expiration date.
Types of Warrant:
There are two types of warrants: call warrants and put warrants.
- Call warrants give the holder the right to buy shares of the underlying security at the strike price. Put warrants give the holder the right to sell shares of the underlying security at the strike price.
- Put and call warrants are categorized by their exercise style. Call warrant when the underlying asset price is lower than the exercise price and Put warrant when the underlying asset price is higher than the exercise price.
Difference Between Stock Warrant and Stock Option:
A stock warrant directly involves the company, whereas a stock option doesn’t involve a company, it’s a contract between two investors. A stock option is entitled to a shorter period such as weeks, months, two, or three years, whereas, a stock warrant is entitled to a longer period such as five, ten, or fifteen years.
Pros and Cons of Warrant
Warrant helps in raising capital for the company. It encourages investors to invest for a longer period. It gives the right to buy and sell without any obligation.
Pros:
Warrants can provide lower upfront cost for an underlying asset for a lower rather than direct ownership. As a result, a warrant gives you leverage, which means small changes in the value of the underlying asset can give larger changes in the value of the warrant. Warrants can be a valuable addition to an investment portfolio, as they can provide downside protection and the potential for upside gains.
Cons:
The biggest risk with warrants is not utilizing them at the proper time in which case the warrant ends up worthless.
So, the conclusion about the warrant is that it’s a good financial instrument for a longer period of investment and profit-making. And like any other financial instrument, it also has some drawbacks which we need to consider before making any investment to avoid loss.