While rights protect existing shareholders from dilution, warrants serve a completely different purpose. They're attached to a bond or preferred stock offering as a bonus, making that bond or preferred stock more attractive to buyers.
What Are Warrants?
- Warrants are long-term options to purchase stock at a fixed exercise price
- Issued by the corporation (not the Options Clearing Corporation, or OCC)
- Typically expire in 2-5 years (some are perpetual)
- Often attached to bonds or preferred stock as a "sweetener" to make the offering more attractive
- Exercise price is set above the current market price at issuance
- Can be detached from the original security and traded separately
- When exercised, the company issues new shares (dilutive to existing shareholders)
Exam Tip: Gotchas
- Warrants are issued by the CORPORATION, not the OCC. Exchange-traded options are cleared through the OCC; warrants are not.
- Exercise price is set ABOVE market price at issuance (the opposite of rights, which are set below).
Rights vs. Warrants
This comparison is frequently tested on the SIE:
| Feature | Rights | Warrants |
|---|---|---|
| Duration | Short-term (30-45 days) | Long-term (2-5+ years) |
| Exercise price | Below market price | Above market price at issuance |
| Purpose | Prevent dilution | Sweeten bond or preferred stock offerings |
| Issued to | Existing shareholders only | Anyone buying the bond or preferred stock the warrant is attached to |
| Effect on shares | New shares issued | New shares issued |
Exam Tip: Gotchas
- Warrants are bundled with a bond or preferred stock offering as a sweetener, not sold on their own. Rights are offered directly to existing shareholders.
- Duration is a common trap: warrants last years, rights last days.
How Warrants Work
- A company issues bonds with warrants attached to make the bonds more appealing
- Investors buy the bonds and receive warrants as a bonus
- If the stock price rises above the warrant's exercise price, the warrant becomes valuable
- The warrant can be detached and traded independently of the bond
- When exercised, the company issues new shares at the exercise price
Think of it this way: A warrant is like a coupon attached to a bond that says "buy our stock at $50 anytime in the next 5 years." If the stock climbs to $80, that coupon is worth real money. The company gets investors to buy the bond today; the investor gets a shot at stock gains tomorrow.
Exam Tip: Gotchas
- Both rights AND warrants create NEW shares when exercised (dilutive). This is different from exchange-traded stock options cleared through the OCC, which involve existing shares changing hands.