Equity Warrant Bonds Free Essay Example

Equity warrant bonds are bonds issued with equity warrants attached. Warrants are similar to share options, and give their holder the right but not the obligation to subscribe for a fixed quantity of equity stocks in the company at a future date, and at a fixed subscription price (exercise price). When bonds are issued with warrants, the warrants are detachable and can be sold in the stock market separately from the bonds. Investors might therefore subscribe to an issue of equity warrant bonds, hold the bonds to maturity (as a long-term investment) and sell the warrants in the stock market fairly soon after purchase.

Equity warrant bonds are unsecured, and offer a lower coupon rate of interest than similar straight bonds issued at the same time and for the same maturity. In these respects, they are similar to convertible bonds. A feature of equity warrant bonds is that if the warrants are exercised, the money obtained from issuing the new stocks can be used to help redeem the bonds.

The debt capital therefore will be replaced, in part at least, by new equity. Equity warrant bonds were used extensively in 1988–89 by Japanese companies to raise capital in the euro convertibles market.

Most had a five-year term, with the warrants exercisable at maturity of the bonds. Following the start of the collapse in Japanese share prices in 1989, the warrants linked to the bond issues became worthless because they had an exercise price well above the current share price. When some of these equity warrant bond issues matured in the mid-1990s, cash had to be found to redeem the bonds. Because share prices were then quite low, some of the companies were able to issue new equity warrant bonds.

The cash from the new bond issues was used to redeem the maturing debt. Since the collapse of the late 1980s, equity warrant bonds have not regained their popularity. In the late 1990s they have had limited, specialist appeal, notably in Germany and Switzerland. Another development specific to the late 1990s is the rise of the exchangeable market. These are bonds that the issuer redeems in another company’s stocks, often allowing it to divest non-core stockholdings.

In France and Japan, for instance, a large proportion of stocks in companies are held by other companies, rather than by insurance or pension funds. Derivatives can be a better way of rationalizing such corporate cross-holdings than selling them in the market. Interest on convertible bonds and equity warrant bonds is usually an allowable charge for tax purposes, so that their after-tax cost to the company is lower than the gross yield to investors. Dividends on preferred stocks, on the other hand, are not an allowable expense for tax purposes.

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