Pricing of Covered Warrants in Equity Markets Empirical Evidence

Question: Discuss about the Pricing of Covered Warrants in a Thin and Developed Equity Markets Empirical Evidence. Answer: Introduction A new type of financial instrument in the year 1998, was introduced to the market of Italy known as covered warrants. Approximately 3500 issues at the end of 2002 were listed covered warrant market. The covered warrant allows the holders to sell or purchases of currency and equities from the issuer at a specific time and price. The diffusion of the covered warrants is due to its simplicity of use and its use as the substitutes of the derivatives (Besley, 2016). The investors have joined the world of derivatives and purchasing the covered warrants which are the financial instruments that derives their values from the performances of other assets such as stock exchanges indices, shares, interest rates, currencies, and commodities. Distinctions between covered warrants, equity warrant, equity option The covered warrant is referred to a type of warrant that allows the holders to sell or purchase a specific amount of currency and equities from the issuer. The equity warrant is the instruments that give the right to the holder to purchase the stocks at a predetermined price. The buyer of the warrants needs to make the upfront payment to gain the right to the warrants issuer. The equity options have the powers to protect, diversify or develop the share portfolio because it can be used regardless of conditions of the share market (Britton and Waterston, 2013). Covered warrants Equity warrant Equity option Covered warrants are the security options that are issued by the third party. Covered warrants work in a similar way to the options contracts that allows the private investors to carry out trade in the prices of assets such as currencies, global indices, equities, and commodities. The covered warrants generate a return if the prices of the underlying assets have increased above the strike price before the maturity date. The warrants are issued by the way of the preferential allotment to institutional investors, promoters and other investors. Equity warrants protect the participants of the market from the defaulting counterparties and provide the hedging opportunities. The equity warrants are not the equity shares because they do not carry any voting or dividend rights. It is issued by the organization during the period of financing in order to purchase the security. The equity options are commonly used by the market participants which includes investors seeking exposure to movements of the shares for a fraction of the cost of an actual share. Traders and brokers can access the options listed on the stock exchange through a technology platform that offers dual options structure of the market. The equity option allows the regulators to gain the exposure to the share price movements for less than the actual share cost. Issuing warrants The organizations issue warrants in order to raise funds to meet the needs of the business operations and expanding its operations. The companies can also sell the stocks and regulated by the securities and exchange commission. Some organizations issue the warrants to crystalize the deal during a restructuring or takeover. Warrants are considered as an investment for an organization to offer (Duguid, 2017). The warrants provide the investors a wide opportunity for high returns and also has a higher risk. Thus, the company issues warrant to increase their funds and expand their business operations. Warrants, like the options, provides the buyer the right to purchase the stocks. Types of investment warrant Warrants are of different types, and the stock warrants can be put and call warrants. Call warrants: The call warrants give the right to the investors to purchase the underlying stocks. The put warrants give the right to the investors to sell their underlying stock. The former presents specific numbers of shares that can be purchased at a specific price from the issuer (Helbk, Lindset and McLellan, 2010). The latter present certain amount of equities that can be sold back at a specific price to the issuer. Covered warrants: The covered warrant has the underlying backings. Beforehand, the issuer can purchase the stocks. The index warrants us used as an underlying asset as the index warrant. Traditional warrants: The traditional warrants are being issued in conjunction with the bond. The buyer is given the right to purchase the stock of the organization (Welch, 2014). Naked warrants: The naked warrant is issued without the bond and a traditional warrant is traded on the stock exchange (Powers and Needles, 2012). The naked warrant is also known as the covered warrants. Benefits, and disadvantages of issuing warrants The issuing of warrants provides a wide opportunity to the companies to raise their funds and expand their business operations. The advantages and disadvantages of issuing warrants are as follows: Benefits of issuing warrants The warrants can be transferrable and it tends to be more attractive for long term and short term investment plans. Warrants are considered as a high return investment technique. They are an attractive option for hedgers and speculators (Rahman, 2015). The company uses the warrants to increase the funds and invest into core activities. It allows balanced financing between equity and debt. Disadvantages Because of the leverage, gearing and lower price, it offers high risk. They can be exercised when the company has to need for increasing more capital (Steele, 2009). When the warrants are exercised, then it will result in the dilution of the common stock that in turns lower the price of the stock in the market. Conclusion The warrants are issued by the companies in order to expand the business operations. The investors purchase the warrants and high risk associated with it. The stock warrants give the holders the rights but not the obligations to purchase the underlying the security at a certain price. The companies issue the share, and it is purchased by the investors. References Besley, S. (2016).Corporate finance. [Place of publication not identified]: Cengage Learning. Britton, A. and Waterston, C. (2013).Financial accounting. Harlow: Financial Times Prentice Hall. DUGUID, C. (2017).STOCK EXCHANGE. [S.l.]: ROUTLEDGE. Helbk, M., Lindset, S. and McLellan, B. (2010).Corporate finance. Maidenhead, Berkshire: Open University Press/McGraw-Hill Education. Powers, M. and Needles, B. (2012).Financial accounting. [Mason]: South-Western, Cengage Learning. Rahman, N. (2015).Corporate Finance. North Ryde: McGraw-Hill Australia. Steele, J. (2009).The Market. New York: Disney/Hyperion Books. Welch, I. 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