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Valuation of Convertible Bonds

Price appreciation with a warrant Managerial Finance 11 text problem #13

Assume you can buy a warrant for $5 that gives you the option to buy one share
of common stock at $14 per share. The stock is currently selling at $16 per share.
a. What is the intrinsic value of the warrant?
b. What is the speculative premium on the warrant?
c. If the stock rises to $24 per share and the warrant sells at its theoretical
value without a premium, what will be the percentage increase in the stock
price and the warrant price if you bought the stock and the warrant at the
prices stated above? Explain this relationship.

Solution Preview

Assume you can buy a warrant for $5 that gives you the option to buy one share of common stock at $14 per share.
The stock is currently selling at $16 per share.

Investopedia Says... the intrinsic value is the difference between the warrant's exercise price and the market price of the underlying. The premium is anything paid above the intrinsic value for the warrant. Typically the premium will decrease as the price of the warrant rises and the time to expiration decreases.
(www.investopedia.com)
a. What is the intrinsic value of the warrant?
I = (M-E) X N
Where:
I = ...

Solution Summary

This explains the computation of intrinsic value of the warrant and speculative premium.

$2.19