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CFO Fundamentals: Your Quick Guide to Internal Controls, Financial Reporting, IFRS, Web 2.0, Cloud Computing, and More by ALLISON I. SHIM, JOEL G. SIEGEL, JAE K. SHIM

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CHAPTER TWENTY-SIX

Warrants and Convertibles

WARRANTS AND CONVERTIBLES are unique compared to other types of securities because they may be converted into common stock. The CFO needs to have a good understanding of warrants and convertibles along with their valuation, their advantages and disadvantages, and when their issuance is recommended.

WARRANTS

A warrant is the option given stockholders to buy a predetermined number of shares of stock at a given price. Warrants may be detachable or nondetachable. A detachable warrant may be sold separately from the bond with which it is associated. Thus, the holder may exercise the warrant but not redeem the bond. Your company may issue bonds with detachable warrants to purchase additional bonds so as to hedge the risk of adverse future interest rate movements, since the warrant is convertible into a bond at a fixed interest rate. If interest rates increase, the warrant will be worthless, and the issue price of the warrant will partially offset the higher interest cost of the future debt issue. A nondetachable warrant is sold with its bond to be exercised by the bond owner simultaneously with the convertible bond.

Your company may sell warrants separately (e.g., American Express) or in combination with other securities (e.g., MGM).

To obtain common stock, the warrant must be given up along with the payment of cash, called the exercise price. Although warrants usually mature on a specified date, some are perpetual. A holder of a warrant ...

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