Wednesday, July 30, 2014

Investors, beware of conversion ratio in warrants

This article appeared in The Edge on Apr 28, 2014

I was intrigued by BFM’s 9.30am Wednesday show with Salvatore Dali on the 2nd of April.  It was about warrants, specifically the frustration around the conversion ratio in the Datasonic call warrants. I would like to take this opportunity to deliberate further on this subject to alert investors, especially novices, about the conversion ratio in warrants.

When we speak of warrants, we are frequently concerned about the moneyness of the warrant (i.e. its exercise price vs. the underling share price), the time to maturity and the volatility of the underlying share price. We expect market players to react to these key parameters, which result in the warrant price in the market. However hidden somewhere in the term sheet is the conversion ratio of warrants, which if missed by investors, will lead to an inaccurate expectation of the profits upon settlement. The conversion ratio is the number of warrants needed in order to buy (or sell) one share. Therefore, if the conversion ratio (warrant : share) to buy a share is 3:1, the holder needs three warrants in order to purchase one share.

In this article I wish to explain the logic for having conversion ratios in certain kinds of warrants. This is followed by a worked out real life example showing how the profits and gearing of warrants