Stock warrants

A stock warrant gives its holder the right — but not the obligation — to purchase shares of the issuing company's stock at a fixed exercise price. Unlike exchange-listed call options, which are created by the options market, warrants are issued by the corporation itself, and exercising them causes the company to issue new shares, diluting existing stockholders.

Warrants are typically issued with an exercise price above the current market price — they start out of the money — but they compensate with very long lives, often five to ten years or more (some are even perpetual). The bet is that the stock will eventually climb past the exercise price, at which point the warrant has intrinsic value. Until then, the warrant trades on time value alone and can be bought and sold like any other security.

Companies usually attach warrants to bond or preferred stock offerings as a sweetener: the equity upside lets the issuer offer a lower interest rate on the bonds. Warrants contrast neatly with preemptive rights, which are distributed to existing shareholders, carry an exercise price below the current market price, and expire within weeks. A useful mnemonic: rights are short-term and issued in the money; warrants are long-term and issued out of the money.

The Series 63, Series 65, and Series 66 exams treat warrants both as an investment vehicle and as a definitions issue — under the Uniform Securities Act, giving a warrant as a bonus with a securities purchase is considered an "offer" of the underlying stock. Know how warrants differ from rights and from listed options, and how they affect dilution.