The objective of this paper is to determine the pricing efficiency and behavior of equity warrants traded in the Bursa Malaysia. Specifically, this paper focuses on the studies of 85 randomly selected samples of listed warrants (46 main board warrants, while the remaining 39 were second board warrants) for the trading period of 100 days from January 1, 2004 until May 31, 2004. The model for pricing of warrants in this study is primarily based on the BlackScholes Option Pricing Model (BSOPM). The theoretical price derived using the BSOPM is then adjusted to incorporate the dilution effect. The adjusted theoretical pricing is then compared with the actual market prices of warrants to determine the pricing efficiency. The paper also looks into related issues such as the extent of mispricing, factors that could lead to the inefficiencies, volatility of the warrants and the underlying stocks, the behavior of price relationships and appropriate strategies to be adopted with regard to the findings. The study concludes that there is significant mispricing on most of the traded warrants, which can be categorized as underpriced, overpriced and extremely overpriced. A few warrants, nevertheless, are found to be insignificantly mispriced.
Equity warrants, hereby referred to as warrants, belong to the family of call options. It basically
gives the right to the holder to purchase new shares. The writer of the call option is required
to deliver existing assets, in this case the share equity or type specified in the option terms, to
the holder of the warrant. Therefore, the exercise of equity warrants by the holder will
automatically increase the number of shares outstanding of a company.
Despite warrants belonging to the options family, there are significant differences between
warrants and options, particularly relating to the dilution of the issuing company’s share capital
base, the originator of the transaction, and time to maturity.
The exercise of warrants will increase the number of shares outstanding and bring fresh
cash into the firm, both of which will affect stock price. The exercising of option, nevertheless,
does not affect the value of the underlying asset. On the maturity period, warrants have longer
maturity than options. In Malaysia, warrants’ maturities vary from five to ten years while options
have a maturity of less than a year. Writers of warrants are, in effect, issuers or borrowers who
are optioning their own securities. An issue of warrants is, thus, a capital raising or cost of capital raising exercise. In the case of options, the writer of the call is most likely not the owner
or custodian of the assets. The writer of a listed call option is someone other than the entity
whose liabilities are being optioned. Such a writer could be regarded as an investor or
speculator in the fortunes of a particular company. |
