Warrants

1. Warrants • A warrant is a security that entitles the holder to buy stock of the issuing company at a specified price, which is usually higher than the stock price at time of issue. • a warrant is a security that entitles the holder to buy stock of the issuing company at a specified price, which is usually higher than the stock price at time of issue. • They can be used to enhance the yield of the bond, and make them more attractive to potential buyers. • Warrants can also be used in private equity deals. Frequently, these warrants are detachable, and can be sold independently of the bond or stock.

2. A certificate, usually issued along with a bond or preferred stock, entitling the holder to buy a specific amount of securities at a specific price, usually above the currentmarket price at the time of issuance, for an extended period, anywhere from a few years to forever. • In the case that the price of the security rises to above that of the warrant's exercise price, then the investor can buy the security at the warrant's exercise price and resell it for a profit. • Otherwise, the warrant will simply expire or remain unused. Warrants are listed on optionsexchanges and trade independently of the security with which it was issued. also calledsubscription warrant.

3. Structure and features • Warrants have similar characteristics to that of other equity derivatives, such as options, for instance: • Exercising: A warrant is exercised when the holder informs the issuer their intention to purchase the shares underlying the warrant. • The warrant parameters, such as exercise price, are fixed shortly after the issue of the bond. • With warrants, it is important to consider the following main characteristics: • Premium: A warrant's "premium" represents how much extra you have to pay for your shares when buying them through the warrant as compared to buying them in the regular way.

4. Gearing (leverage): A warrant's "gearing" is the way to ascertain how much more exposure you have to the underlying shares using the warrant as compared to the exposure you would have if you buy shares through the market. • Expiration Date: This is the date the warrant expires. If you plan on exercising the warrant you must do so before the expiration date. • The more time remaining until expiry, the more time for the underlying security to appreciate, which, in turn, will increase the price of the warrant (unless it depreciates). • Therefore, the expiry date is the date on which the right to exercise no longer exists.

5. Restrictions on exercise: Like options, there are different exercise types associated with warrants such as American style (holder can exercise anytime before expiration) or European style (holder can only exercise on expiration date).[1] • Warrants are longer-dated options and are generally traded over-the-counter. • There are two different types of warrants: a call warrant and a put warrant. • A call warrant represents a specific number of shares that can be purchased from the issuer at a specific price, on or before a certain date. • A put warrant represents a certain amount of equity that can be sold back to the issuer at a specified price, on or before a stated date.

6. Advantages • Because the prices of warrants are low, the leverage and gearing they offer is high. This means that there is a potential for larger capital gains and losses. • While it is common for both a share price and a warrant price to move in parallel (in absolute terms) the percentage gain (or loss), will be significantly varied because of the initial difference in price. • Warrants generally exaggerate share price movements in terms of percentage change. • Example, XYZ shares are currently priced on the market for $1.50 per share. In order to purchase 1,000 shares, an investor would need $1,500. However, if the investor opted to buy a warrant (representing one share) that was going for $0.50 per warrant, with the same $1,500, he or she would be in possession of 3,000 shares instead!

7. share XYZ gains $0.30 per share from $1.50, to close at $1.80. The percentage gain would be 20%. However, with a $0.30 gain in the warrant, from $0.50 to $0.80, the percentage gain would be 60%. • Warrants can offer significant gains to an investor during a bull market. • They can also offer some protection to an investor during a bear market. • This is because as the price of an underlying share begins to drop, the warrant may not realize as much loss because the price, in relation to the actual share, is already low.

8. Disadvantages • Like any other type of investment, warrants also have their drawbacks and risks. As mentioned above, the leverage and gearing warrants offer can be high. But these can also work to the disadvantage of the investor. If we reverse the outcome of the example from above and realize a drop in absolute price by $0.30, the percentage loss for the share price would be 20%, while the loss on the warrant would be 60%! • Another disadvantage and risk to the warrant investor is that the value of the certificate can drop to zero. If that were to happen before it is exercised, the warrant would lose any redemption value. • Finally, a holder of a warrant does not have any voting, shareholding or dividend rights. The investor can therefore have no say in the functioning of the company, even though he or she is affected by any decisions made.

9. Types of warrants • A wide range of warrants and warrant types are available. The reasons you might invest in one type of warrant may be different from the reasons you might invest in another type of warrant. • Equity warrants: Equity warrants can be call and put warrants. • Callable warrants: give you the right to buy the underlying securities • Putable warrants: give you the right to sell the underlying securities • Covered warrants: A covered warrant is a warrant that has some underlying backing, for example the issuer will purchase the stock before hand or will use other instruments to cover the option. • Basket warrants: As with a regular equity index, warrants can be classified at, for example, an industry level. Thus, it mirrors the performance of the industry.

10. Index warrants: Index warrants use an index as the underlying asset. Your risk is dispersed—using index call and index put warrants—just like with regular equity indexes. It should be noted that they are priced using index points. That is, you deal with cash, not directly with shares. • Wedding warrants: are attached to the host debentures and can be exercised only if the host debentures are surrendered • Detachable warrants: the warrant portion of the security can be detached from the debenture and traded separately. • Naked warrants: are issued without an accompanying bond, and like traditional warrants, are traded on the stock exchange. • They are typically issued by banks and securities firms. These are also called covered warrants, and are settled for cash, e.g. do not involve the company who issues the shares that underlie the warrant.

11. Traditional warrants: Traditional warrants are issued in conjunction with a Bond (known as a warrant-linked bond), and represent the right to acquire shares in the entity issuing the bond. In other words, the writer of a traditional warrant is also the issuer of the underlying instrument. Warrants are issued in this way as a "sweetener" to make the bond issue more attractive, and to reduce the interest rate that must be offered in order to sell the bond issue. • Third-party warrants: Third-party warrant is a derivative issued by the holders of the underlying instrument. Suppose a company issues warrants which give the holder the right to convert each warrant into one share at Rs.500. This warrant is company-issued. Suppose, a mutual fund that holds shares of the company sells warrants against those shares, also exercisable at Rs 500 per share. These are called third-party warrants. • The primary advantage is that the instrument helps in the price discovery process.

12. Interbank Rate • The rate of interest charged on short-term loans made between banks. •  Banks borrow and lend money in the interbank market in order to manage liquidity and meet the requirements placed on them. • The interest rate charged depends on the availability of money in the market, on prevailing rates and on the specific terms of the contract, such as term length. • Banks are required to hold an adequate amount of liquid assets, such as cash, to manage any potential withdrawals from clients. • If a bank can't meet these liquidity requirements, it will need to borrow money in the interbank market to cover the shortfall. • Some banks, on the other hand, have excess liquid assets above and beyond the liquidity requirements. • These banks will lend money in the interbank market, receiving interest on the assets.

13. These are short term instruments to even out liquidity within the banking system. The objective is to provide some degree of flexibility in the credit portfolio of banks and smoothen consortium arrangements. • This is purely an inter bank instrument. The RBI has authorised the banks to fund their short term needs from within the system through issuance of IBPC. • Reserve Bank of India has been decided that henceforth, Regional Rural Banks (RRBs) can also issue Inter-Bank Participation Certificates (IBPCs) of a tenor of 180 days on risk sharing basis to scheduled commercial banks against their priority sector advances in excess of 60% of their outstanding advances.

14. Scheme of Inter Bank Participations- RBI Guidelines • There will be two types of Participations:I. Inter-Bank Participations with Risk Sharing II Inter-Bank Participations without Risk Sharing. The Participations would be strictly inter bank confined to scheduled commercial banks. • The aggregate amount of such IBPs under any loan account at the time of issue is not to exceed 40 per cent of the outstanding in the account. • I. Inter-Bank Participations with Risk SharingThe primary objective of the Participations is to provide some degree of flexibility in the credit portfolio of banks and to smoothen the working of consortium arrangements. 1. Applicability of the Scheme: The scheme will be confined to scheduled commercial banks.

15. 2. Period of Participations: The minimum period of such a Participation will be 91 days, while the maximum period will be 180 days. 3. Rate of Interest: The rate of interest on Participations would be left free to be determined between the issuing bank and the participating bank, subject to a minimum of 14.0 per cent per annum. Participations will not be transferable. II. Inter-Bank Participations without risk sharingThe primary objective of this type of Participation is to even out short term liquidity. The Participation should be backed by the cash credit accounts of the borrowers.1. Applicability of the scheme: The scheme will be confined to scheduled commercial banks only.

16. 2. Period of Participation: The tenure of such Participations will not exceed 90 days.3. Rate of Interest: The rate of interest would be determined by the two concerned banks subject to a ceiling of 12.5 per cent per annum.Participation will not be transferable.

17. Bonds • A bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. • A bond is a formal contract to repay borrowed money with interest at fixed intervals. • Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. • Certificates of deposit (CDs) or commercial paper are considered to be money market instruments but not bonds. Bonds must be repaid at fixed intervals over a period of time.

18. Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders). • Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity).

19. Features: The most important features of a bond are: • nominal, principal or face amount — the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end. Some structured bonds can have a redemption amount which is different to the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate or a fund. This can result in an investor receiving less or more than his original investment at maturity. • issue price — the price at which investors buy the bonds when they are first issued, which will typically be approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the issue price, less issuance fees.

20. maturity date — the date on which the issuer has to repay the nominal amount. As long as all payments have been made, the issuer has no more obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. • Most bonds have a term of up to thirty years. Some bonds have been issued with maturities of up to one hundred years, and some even do not mature at all. In early 2005, a market developed in euros for bonds with a maturity of fifty years. • In the market for U.S. Treasury securities, there are three groups of bond maturities: • short term (bills): maturities up to one year; • medium term (notes): maturities between one and ten years; • long term (bonds): maturities greater than ten years.

21. coupon — the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or it can be even more exotic. The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment. • coupon dates — the dates on which the issuer pays the coupon to the bond holders. In the U.S. and also in the U.K. and Europe, most bonds are semi-annual, which means that they pay a coupon every six months. • Optionality: Occasionally a bond may contain an embedded option; that is, it grants option-like features to the holder or the issuer: • Callability — Some bonds give the issuer the right to repay the bond before the maturity date on the ; see call option. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called . This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.

22. Putability — Some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates; see put option. (Note: "Putable" denotes an embedded put option; "Puttable" denotes that it may be putted.) • call dates and put dates—the dates on which callable and putable bonds can be redeemed early. There are four main categories. • A Bermudan callable has several call dates, usually coinciding with coupon dates. • A European callable has only one call date. This is a special case of a Bermudan callable. • An American callable can be called at any time until the maturity date. • A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of the deceased to put (sell) the bond (back to the issuer) in the event of the beneficiary's death or legal incapacitation. Also known as a "survivor's option". • sinking fund provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.

23. Types of bonds: The following descriptions are not mutually exclusive, and more than one of them may apply to a particular bond: • Fixed rate bonds have a coupon that remains constant throughout the life of the bond. • Floating rate notes (FRNs) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor. For example the coupon may be defined as three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months. • Zero-coupon bonds pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government. Zero-coupon bonds may be created from fixed rate bonds by a financial institution separating "stripping off" the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately. See IO (Interest Only) and PO (Principal Only).

24. Inflation linked bonds, in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The United Kingdom was the first sovereign issuer to issue inflation linked Gilts in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government. • Other indexed bonds, for example equity-linked notes and bonds indexed on a business indicator (income, added value) or on a country's GDP. • Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBS's), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs). • Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks, and asset-backed securities. The latter are often issued in tranches. The senior tranches get paid back first, the subordinated tranches later.

25. Perpetual bonds are also often called perpetuities. They have no maturity date. The most famous of these are the UK Consols, which are also known as Treasury Annuities or Undated Treasuries. Some of these were issued back in 1888 and still trade today, although the amounts are now insignificant. Some ultra-long-term bonds (sometimes a bond can last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e. 24th century)) are virtually perpetuities from a financial point of view, with the current value of principal near zero. • Bearer bond is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets. • Registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner.

26. War bond is a bond issued by a country to fund a war. • Serial bond is a bond that matures in installments over a period of time. In effect, a $100,000, 5-year serial bond would mature in a $20,000 annuity over a 5-year interval. • Revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds. Revenue bonds are typically "non-recourse," meaning that in the event of default, the bond holder has no recourse to other governmental assets or revenues. • Lottery bond is a bond issued by a state, usually a European state. Interest is paid like a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule. Some of these redemptions will be for a higher value than the face value of the bond.

27. Government Bonds: These are fixed-income debt securities issued by the government. Government bonds are further categorized on the basis of the term (maturity duration). (a) Government Bills: These are government bonds with a maturity period of less than one year. (b) Government Notes: These are government bonds with a maturity period from one year to ten years. (c) Government Bonds: These are government bonds with a maturity period that exceeds ten years. • Municipal Bonds: These are debt securities issued by state governments and their agencies. The interest is exempt from federal income tax or local tax. • Corporate Bonds: These are debt instruments issued by a company and backed by its ability to generate profits or by the current value of its physical assets. • Bonds issued in foreign currencies : Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies as it may appear to be more stable and predictable than their domestic currency. Issuing bonds denominated in foreign currencies also gives issuers the ability to access investment capital available in foreign markets. The proceeds from the issuance of these bonds can be used by companies to break into foreign markets, or can be converted into the issuing company's local currency to be used on existing operations through the use of foreign exchange swap hedges. Foreign issuer bonds can also be used to hedge foreign exchange rate risk.

28. Bond Price Variations • A bond's price refers to the amount investors are willing to pay for an existing bond. The bond’s price is important if you wish to trade the bond with another investor. The main factors that impact bond prices are: • Interest rate: When interest rates in the market rise, newly issued bonds become more lucrative (offer higher yields). This makes existing bonds less competitive and exerts pressure on the price of existing bonds. Thus interest rates and bond prices move in opposite directions. • Inflation: High inflation erodes the value of the return that is earned when the bond matures. Thus inflation and bond prices also move in opposite directions. • Financial health of the issuer: The financial health of the company or government that has issued the bond impacts bond prices. If the issuer is financially healthy, investors have greater confidence in receiving the interest payments and principal amount at maturity. Investors typically stay in touch with the ratings issued by reputed credit rating agencies, such as Moody’s and Standard & Poor’s.

29. Advantages of Corporate Bonds • 1.Corporate bonds generally offer higher returns than Government Securities, fixed deposits, CD’s & CP’s. • 2.Corporate bonds are rated by approved rating agencies e.g. CARE, ICRA, CRISIL, FITCH. (We deal in investment grade scrips only). • 3.You can invest in blue-chip corporates with sound credit-quality in a sector of your choice to meet your investment objectives. • 4.Corporate bonds provide you with a steady income stream • .5.You can lock-in high rates for a long period of time. • 6.Secondary market trading is possible, depending upon demand.

30. Dis-advantages of Corporate Bonds • 1.They are generally unsecured and therefore have an element of credit risk. • 2.All Corporate bonds are not actively traded. • 3.They form a very small part of the total debt market. • 4.While interest rate is generally fixed, all debt securities are subject to market risk, i.e. the price at which they are traded could vary. • 5.Unlike Gilts where RBI sometimes steps in to put trades, there are no market makers in corporate bonds. • 6.·The minimum lot is generally bigger for corporate bonds compared to retail G-Secs. • 7.·Stamp Duty is payable on issue and transfer in some states