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Warrants

What Is A Warrant?

A warrant is a security that gives the holder the right to purchase a company's stock or bond at a specific price by a certain date.

Warrants are similar to options, but warrants are issued directly by a company, usually as an incentive to get investors to buy the company's stock or bonds. Options, by contrast, are a contract between two parties in which the holder has the right to buy a security or asset at a specific price and time. Warrants generally are effective for as long as 15 years, while options are short-term contracts that usually last for less than a year.

Warrants have no voting or dividend rights. If the warrants are exercised, the company must issue new stock or bonds.

How Do Warrants Work?

The most notable example of how warrants work is when Berkshire Hathaway agreed to buy $5 billion of preferred stock from Bank of America during the financial crisis in 2011, at a time when the bank's future was in serious doubt.[1] As part of the deal, Berkshire was given warrants to buy 700 million shares of the bank's common stock at a price of US$7.14 a share.

At the time, the bank's shares were trading at about US$7 a share, meaning the warrants were essentially worthless. However, in 2017, when the bank's shares had more than tripled to US$24, Berkshire exercised the warrants, earning a US$12 billion profit and becoming the bank's largest shareholder in the process.[1]

Put And Call Warrants

There are two types of warrants. Call warrants are the most common, and they give the holder the right to buy shares at a certain price in the future. And then there are put warrants, which give the holder the right to sell their shares back to the company at a predetermined price. In the first case, the investor would profit if the price of the underlying stock went up, while the put warrant would provide downside protection if the price went down.

Summary

Warrants are securities that give the owner the right to buy a company's stock or bonds at a predetermined price at a specified future date. Warrants are similar to options except that they are issued directly by a company, usually as an inducement to buy the company's shares or bonds.