Detachable warrant definition
/What is a Detachable Warrant?
A detachable warrant is a derivative that is attached to a debt security, giving the owner the right to buy a certain number of shares of the issuer at a fixed exercise price. The debt issuer includes the detachable warrants in its sale of the debt security in order to obtain a lower interest rate than would be possible without the warrants, while a buyer is interested in the profit it could earn by converting the warrants to stock if the entity’s stock price rises.
A warrant contains the following information:
The time period during which the holder can exercise the right to buy the issuer's shares
The exercise price at which the shares can be purchased
The number of shares that can be purchased
Since this type of warrant is detachable from the debt security with which it is paired, the two elements of a debt offering exist independently and should be treated as separate securities. In fact, an investor could sell a detachable warrant separately on a secondary market, while retaining the debt security. Or, the investor might exercise it and purchase the entity’s stock, or allow it to expire.
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Example of a Detachable Warrant
Imagine Potato Company issues a bond with a detachable warrant as part of the offering to make the bond more attractive to investors. Here are the terms of the issuance:
Bond Face Value: $1,000
Interest Rate on Bond: 5%
Maturity: 10 years
Warrant Terms:
Exercise Price: $50 per share
Expiration: 5 years from the issuance date
Number of Shares Warrant Allows: 10 shares of Potato Company
When an investor buys the bond, they also receive the detachable warrant. They can either:
Sell the bond and keep the warrant (or vice versa).
Sell the warrant independently of the bond if they wish, as it is detachable and can trade separately.
Exercise the warrant if the stock price rises above the $50 exercise price within the 5-year period, enabling them to buy 10 shares at $50 per share even if the market price is higher.
If, for example, Potato Company's stock price rises to $80 within the 5-year period, the warrant holder could exercise the warrant to buy shares at the discounted price of $50, providing a profit potential. Alternatively, the holder could sell the warrant itself at a premium due to the stock's increase in value.