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Comparing returns on warrants and stocks

The Redford Investment Company bought 100 Cinema Corp warrants one year ago and would like to exercise them today. The warrants were purchased at $24 each, and they expire when trading ends today (assume there is no speculative premium left). Cinema Corp common stock is selling today for $50 per share. The exercise price is $30 and each warrant entitles the holder to purchase two shares of stock, each at the exercise price.

Assume the Cinema Corp common stock was selling for $40 per share when the Redford Investment company bought the warrants.

a. What was the intrinsic value of a warrant at that time?
b. What was the speculative premium per warrant when the warrants were purchased?
c. What would the Redford Investment Company's total dollar profit or loss have been had it invested the $2,400 directly in Cinema Corp's common stock one year ago at $40 per share and sold it today at $50 per share?
d. What would the percentage rate of return be on this common stock investment? Compare this to the rate of return on the warrant investment computed in the Redford Investment Co. (1st paragraph) situation above.

Solution Preview

a. Intrinsic Value at the time warrant was purchased was (2*40 - 2*30 = $20). Keep in mind that each warrant entitles the holder to purchase two shares of stock. That is why, I multiplied by 2.

b. Speculative premium per ...

Solution Summary

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