How warrants are valued

The price of a warrant ultimately is determined by market forces. However, it is important to have some understanding of the various influences on warrant prices.

How the warrant is priced will depend on the type of warrant. The following information is predominantly used to explain how trading warrants are
valued. However, some aspects can be used to illustrate how instalments and other types of warrants are priced.

The market value of a warrant can be divided into two components - intrinsic value and time value.
Intrinsic value
Intrinsic value is the difference between the exercise price of the warrant and the current price of the underlying asset. It is always greater than or equal to zero.

If a warrant has intrinsic value, it is said to be ‘in-the-money’.

Warrants are also referred to as at-the-money or out-of-the-money, depending on where the current asset price is in relation to the warrant’s exercise price.
Exercise price < asset Exercise price = asset Exercise price > asset
price price price
Call warrant in-the-money at-the-money out-of-the-money
Put warrant out-of-the-money at-the-money in-the-money
Time value
Time value can be considered as the value of the continuing exposure to the movement in the underlying security that the warrant provides.

Time value is heavily influenced by whether the warrant is in-the-money, at-the-money or out-of-the-money. It will be greatest when the warrant is at-the-money.

Time value declines as the expiry of the warrant draws closer. This erosion of time value is called time decay. It is not constant, but increases rapidly towards
expiry.

A warrant’s time value is affected by the following factors:

Time to expiry

The longer the time to expiry, the greater the time value of the warrant.

Volatility
The more volatile the underlying instrument, the higher the price of the warrant will be, all other things being equal.

This is because the price of the underlying asset has a greater probability of moving above (for a call) or below (for a put) the exercise price of the warrant, which
makes the warrant more valuable.

Interest rates
An increase in interest rates will lead to more expensive call warrants and cheaper put warrants, all else being equal.

This reflects the cost of funding the underlying asset. By buying a call warrant you can defer paying for the underlying asset until the warrant’s expiry date, and
invest the funds elsewhere during this period. As interest rates rise, more interest can be earned on the funds, so the call warrant is worth more to you.

The effect of an interest rate rise is the opposite for put warrants, as you are deferring the receipt, rather than the expenditure of funds.

Dividends
The effect of dividend payments varies depending on the type of warrant, and any entitlement of the warrant holder to receive dividends paid on the underlying
asset.

Generally, if a dividend is payable during the life of a warrant, the cost of a call warrant will be lower, and the cost of a put warrant higher, compared to if no
dividend was payable.

However, it is also relevant to consider whether the warrant is American or European in exercise style.

Furthermore, some warrants entitle the warrant holder to dividends paid on the underlying shares, which will significantly affect the warrant’s price.

You should ask your accredited derivatives adviser about the impact of dividends on a particular warrant.

Other influences
Other non quantifiable factors such as supply and demand, investor sentiment, and general market expectations can also influence the market value of a warrant.
The warrant price may be influenced by the issuer's ability to offset his risk by buying or selling the underlying asset or another derivative.

For more information about which models are used to evaluate warrants, refer to the Pricing Models section.
Guide to Warrants

• Introduction
Since Malaysia's first warrant appeared in 1990, this derivative has gained popularity. The following is only a brief guide on trading in
warrants. Subscribers of i Capital® are encouraged to conduct their own research to fully understand this volatile investment.

• What is a warrant?
A warrant is a right to buy a share of a firm at a certain price during a given time period. A warrant can be exercised ( converted to an
ordinary share ) at any point within this given time period.

• Why does a company issue warrants?

Warrants are often offered as "sweeteners" in a loan stock/bond/rights issue. In the case of a bond/loan stock issue, a warrant may give
the company a lower interest payable on the issued debt.

• How do you put a price on a warrant?

A warrant has 2 values : intrinsic value and time value. Its intrinsic value is the difference between the current price of the underlying
stock and the warrant's exercise price. Factors that positively affect a warrant's time value are the expected volatility of the underlying
stock and the warrant's time to expiration. Other factors to be taken into account are expected dividends from the underlying equity and
market sentiment.