Warrants: Opportunities and Risks

Warrants are financial instruments that allow their holder to purchase shares of a company at a predetermined price, often below the current market price, during a specified period. Since their introduction in the early 20th century, warrants have been used by companies to raise funds and offer investors the potential for high returns. However, these instruments also come with significant risks that are important to understand before investing. This article explores warrants, their advantages, and associated risks.

What is a Warrant?

A warrant is a right, but not an obligation, to purchase a share at a predetermined price (known as the exercise price) during a specified period. For example, a company may issue warrants that allow investors to buy its shares at €50 per share, while the current market price is €60. If the share price rises to €70, the warrant holder can exercise their right and buy the share at €50, realizing an immediate gain of €20 per share.

Opportunities Offered by Warrants

Warrants offer several opportunities to investors:

• Financial leverage: Warrants allow investors to benefit from leverage, as they require a lower initial investment for a potentially high return. For example, if an investor buys a warrant for €5 and the share price increases by €20, the return on the initial investment is very high.
• Advantageous exercise price: If the exercise price is below the share price, the investor can buy the share at a discounted price, increasing their potential for gain.

Risks Associated with Warrants

Despite their opportunities, warrants come with significant risks:

• Total loss risk: If the share price does not exceed the exercise price before the warrant expires, the warrant becomes worthless, resulting in a total loss of the initial investment.
• High volatility: Warrants are sensitive to market fluctuations and can quickly lose value if the underlying share price drops.

Real-Life Example

In 2023, a technology company issues warrants allowing the purchase of its shares at €100 per share. If, by the end of 2024, the share price reaches €150, warrant holders can exercise their right and realize a gain of €50 per share, after paying the exercise price of €100.

Laws Governing Warrants

In France, warrants are governed by the Commercial Code and the Monetary and Financial Code, which regulate the conditions of issuance, information transparency, and holder rights. The Financial Markets Authority (AMF) ensures investor protection by ensuring that issuers comply with legal and regulatory obligations.

Conclusion

Warrants can offer attractive investment opportunities, thanks to their leverage effect and the ability to acquire shares at a favorable price. However, they also come with significant risks, including the risk of total loss of investment. It is essential for investors to understand these risks and integrate them into a broader investment strategy. Before investing in warrants, it is recommended to consult a financial advisor to ensure that this type of instrument aligns with your goals and risk tolerance.