Islamic Investment : Call warrant

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CALL WARRANTS

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Transcript of Islamic Investment : Call warrant

Page 1: Islamic Investment : Call warrant

CALL WARRANTS

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Call warrants is an alternative investment that investor can invest in Bursa Malaysia. It can be traded through remises or via online trading, which is similar to trading shares.

The advantage of call warrants – has unlimited upside similar to buying the underlying asset, but the loss is limited to the amount initially invested in the call warrant.

INTRODUCTION

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DEFINITION

Call Warrants:

A financial instrument that gives the holder the right to buy the underlying share at a specific price, on or before a specified date.

included in a new equity or debt offering from a company, in order to provide an added inducement to potential investors.

Usually detachable from the accompanying stock or bond certificate and trade separately on major stock exchanges.

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EXPLAINS 'Call Warrant'

• The price at which the warrant holder can buy the underlying stock is called the exercise price or strike price. It is often set "out-of-the-money“. For example it is fixed at a certain percentage above the current trading price of the underlying stock.– While a call warrant has a strike price and expiration date just like an

option, there are some fundamental differences between the two:i. Warrants are issued by companies ii. Exchange-traded options are listed by an exchange.

Warrants also have much longer expiration periods than options.

– Call warrant feature may enable the company to lower the cost of its debt. The risk of potential equity dilution to the issuer, in the event of all the warrants being exercised, is more than offset by the additional equity capital available to the company at no additional cost, an especially important consideration during periods of severe stress in financial markets.

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OVERVIEW ACCORDING ISLAMIC JURISPUDENCE

• Securities Commision’s Shariah Committee Commission (SAC)

-Call Warrant is approved as permissible- Take the view that the structure and trading

mechanism of stock index future contract fulfill Shariah principal (with condition underlying asset is Shariah compliance)

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WHAT ARE THE PRINCIPAL TERMS IN A CALL WARRANT?

1. Issuer

2. Underlying Asset (e.g. share, a basket of shares, or an

index)

3. Warrant Type (i.e. Call or Put)

4. Warrant Style (e.g. European or American)

5. Exercise Price (or Strike Price)

6. Expiry Date

7. Entitlement or Conversion Ratio

8. Settlement Method

9. Warrant Price

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TYPES OF WARRANTS

1. Call warrant A Call warrant gives the holder the right or choice to

buy a given quantity of the underlying asset at a predetermined price (exercise or strike price), on or before the expiry date, depending on the exercise style of the warrant.

2. Put warrant A Put warrant gives the holder the right to sell given

quantity of the underlying asset at a predetermined price, on or before the expiry date depending on the exercise style of the warrant.

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3. Covered warrants? Covered warrants (or structured warrants) are issued by a company (usually a bank or securities firm) on shares of another listed company, basket of shares or an index.

In Malaysia, only covered call warrants (or "Call Warrants" under the SC’s Guidelines for the issue of Call Warrants) in the form of "fully-collateralized" or "non-collateralized“. Call Warrants are currently permitted to be issued by authorized banks or universal brokers approved by the SC. Put warrants are not yet permitted under the Guidelines.

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"Fully-collateralized" versus "non-collateralized" Call Warrants

CALL WARRANT ISSUEFully-collateralized Non-collateralized

If the issuer deposits the relevan amount of underlying securities with an independent trustee in order to secure the obligations of the issuer and adequately protect the interests of the warrant holders.

If the issuer provides for its obligations in a form other than by way of charge over the underlying securities. The issuer usually adopts dynamic hedging strategies to provide for its obligations under the warrants.

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THE MAJOR DIFFERENCES BETWEEN CALL WARRANTS AND COMPANY WARRANTS

COMPANY WARRANTS CALL WARRANTS

Issuer Same listed company with that of the underlying shares

Authorized bank or universal broker

Underlying asset Shares issued by the listed company

Shares issued by another company, basket of shares or an index

On exerciseNew shares of the company are issued. Results in dilution of shares

Involved existing, already-issued shares. No dilution effect on shares

Expiry date Longer tenure; usually more than 4 years

Shorter tenure; usually less than 4 years

Settlement method Physical delivery of shares Either physical delivery of shares or cash settlement

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How Do Corporate Exercises / Actions Aff ect The Call Warrants?

Call Warrants are subject to adjustments to take into account any corporate actions arising from the underlying stock, or component stocks in the basket. Corporate actions such as rights issue, bonus issue, share splits or consolidation may lead to a diluting or concentrative effect on the theoretical value of the underlying stock or basket. This may result in adjustments to the entitlement, the exercise price or other variables of the Call Warrant.

For index Call Warrants, adjustments are normally not required on the warrant terms for corporate actions related to the component stocks in the index. This is because the underlying index will have already adjusted itself to take into account such corporate actions.

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CHARACTERISTICS I. Call warrants ≠ call options or stock purchase rights

o One important characteristic - are often detachable. That is, if the investors holds a bond with attached warrants, they can sell the warrants and keep the bond.

ii. Call warrants are traded on the major exchangeso In case where it have been issued with preferred stock,

stockholders may not receive a dividend as long as they hold the warrant. Thus it is sometimes advantageous to detach and sell a warrant as soon as possible if the investor expects to earn more from dividends.

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iii. Call warrants tend trade above their minimum valueo For example, consider the warrant to purchase 100 shares of Company XYZ for

$20 per share anytime in the next five years. If Company XYZ shares rose to $100 during that time, the warrant holder could purchase the shares for $20 each, and immediately sell them for $100 on the open market, pocketing a profit of ($100 - $20) x 100 shares = $8,000. Thus, the minimum value of each warrant is $80.

iv. IMPORTANT!! if the warrants still had a long time to expiration, investors might speculate that the price of Company XYZ stock could go even higher than $100 per share

o This speculation, accompanied by the extra time for the stock to rise further, is why a warrant with a minimum value of $80 could easily trade above $80. But as the warrant gets closer to expiring (and the chances of the stock price rising in time to further increase profits get smaller), that premium would shrink until it equaled the minimum value of the warrant (which could be $0 if the stock price falls to below $20 rather than rising above $100).

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What are the factors affecting the price of the Call Warrant?

1) Underlying asset price

2) Exercise price

3) Volatility of the underlying asset price

4) Time to expiry of the warrants

5) Interim interest rates

6) Dividend yield of the underlying asset

7) Credit worthiness of the issuer

8) Supply-demand factor on the warrants

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HOW TO REALIZE THE VALUE ON CALL

WARRANTS?If you hold a Call Warrant, the value of your warrant should appreciate if the underlying share price has risen, assuming other factors remain constant. You can realize the value of the warrant by selling the warrant in the market.

Alternatively, if the warrant is American-style, you can exercise the warrant to buy the shares from the issuer at the exercise price instead of the current market price. Your gain is the difference between the exercise price and the current share price. You can realize this gain immediately by selling the shares in the market (the result would be similar to the case when the warrant is cash settled).

Normally, you would realize more value by selling the warrant, instead of exercising it, if there are still many days remaining before expiry and when there is still "time value". You would only exercise the warrant if the warrant price is below intrinsic value, or because you want to own the underlying shares for some reasons, e.g. to be entitled for the dividend due.

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BEWARE OF "TIME DECAY"!

Unlike shares, warrants have an expiry date and therefore a limited life. As time passes, the time value of a warrant decreases and eventually reaches zero when the warrant expires (except in the case of zero strike call warrants). This is known as "time decay". Means, it costs money each day to hold the warrant and do nothing with it. It is important that you monitor the warrant’s expiry date and performance. Warrants are intended more for trading purposes.

- A warrant may expire before your expectations are realized, making it

worthless. Therefore it is essential that you select a warrant that has

sufficient time to expiry to match your market expectations.

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HOW IT WORKS + EXAMPLE

Occasionally, companies offer call warrants (usually simply called "warrants") for direct sale or give them to employees, but the vast majority of call warrants are "attached" to newly issued bonds or preferred stock.

For example, if Company XYZ issued $100 million of bonds with call warrants attached, each bondholder might get a $1,000 face-value bond and the right to purchase 100 shares of Company XYZ stock at $20 per share over the next five years. Warrants usually permit the holder to purchase common stock of the issuer, but sometimes they allow the purchaser to buy the stock or bonds of another entity (such as a subsidiary or even a third party).

The price at which a call warrant holder can purchase the underlying securities is called the exercise price or strike price. The exercise price is usually higher than the market price of the stock at the time of the call warrant's issuance. In our example, the exercise price is $20, which is probably 15% higher than what Company XYZ stock was trading at when the bonds were issued. The call warrant's exercise price often rises according to a schedule as the bond matures. This schedule is set forth in the bond indenture.

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1. Gearing = Underlying Price Warrant Price x Exercise Ratio

2. Premium = [(Warrant price x Exercise Ratio) + Exercise Price] – Underlying Price Underlying Price

3 . Cash Settlement

= No. Of Call Warrants x 1 x (Closing Price – Exercise Price) Exercise Ratio

Formula To Calculate  Call Warrant Gearing, Premium

And  Cash Settlement .

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NAME CODE MATURITY DATE

DAYS TO MATURITY

EXERCISE PRICE ( RM )

EXERCISE RATIO

AFFIN-CA 5185CA 28/02/2011 202 2.450 3.000

AFG-CB 2488CB 21/02/2011 195 2.400 3.000

AIRASIA-CF 5099CF 21/01/2011 164 1.160 2.000

AMMB-CD 1015CD 17/09/2010 38 2.400 6.000

ANNJOO-CA 6556CA 28/12/2010 140 2.600 4.000

ASTRO-CC 5076CC 24/09/2010 45 3.400 4.000

AXIATA-CB 6888CB 19/08/2010 9 2.247 2.000

BURSA-CO 1818CO 04/02/2011 178 7.700 10.000

DIGI-CE 6947CE 18/05/2011 281 23.000 15.000

EXAMPLE OF LOCAL CALL WARRANTS THAT CURRENTLY TRADED IN BURSA MALAYSIA

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NAME CODE MATURITY

DATEDAYS TO MATURITY

EXERCISE PRICE (RM)

EXERCISE RATIO

CURRENCY CODE

ANZ-C1 0545C1 12/1/2011 147 21.50 60 AUD

BHP-C1 0544C1 12/1/2011 147 42.00 125 AUD

BYD-C1 0548C1 12/1/2011 147 68.00 50 HKD

CHLIFE-C6

0506C6 15/4/2011 240 39.50 20 HKD

HKEX-CC 0505CC 04/2/2011 170 143.90 125 HKD

BRKB-C1 0536C1 16/4/2014 1337 0.00 222.9658 MYR

CMA-C1 0542C1 31/3/2011 225 2.40 8 SGD

GENS-C1 0539C1 02/9/2010 15 0.94 2.8703 SGD

APPLE-C2 0528C2 02/2/2011 168 200.00 1000.00 USD

EXAMPLE OF  FOREIGN CALL WARRANTS THAT CURRENTLY TRADED IN BURSA MALAYSIA