Five years ago, in conjunction with a financial restructuring, Laurenberg Electric sold a $100 million issue of bonds at a coupon interest rate of 12 percent. Each bond came with 30 detachable warrants. Each warrant entitled the holder to purchase one share of Laurenberg's common stock at $15 per share. The warrants were set to expire 25 years from the date of issue. When Laurenberg's stock sold for $7 per share, the value of a warrant in the marketplace was $0.50.
a. What is the formula value of each warrant under these conditions?
b. What factors influence this value?
At a stock price of $15, the market price of each warrant was $3. At a stock price of $20, the market price of each warrant was $6.50. At a stock price of $25, the market price of each warrant was $10.50.
c. If an investor purchases the stock and the warrant when the stock price is $15, what holding period return will be earned on both, assuming that the stock and the warrant are sold when the stock price reaches $20?
d. If an investor purchases the stock and the warrant when the stock price is $20, what holding period return will be earned on both, assuming that the stock and the warrant are sold when the stock price reaches $25?
e. What happens to the rate of return from the warrant as the stock price rises? Why do you think this happens?