1.4 Rights vs. Warrants
Rights and warrants provide holders the option to buy common shares at a fixed subscription price. Series 7 questions constantly contrast their duration, pricing relative to market, and issuance rationale.
Key FINRA Exam Takeaways
- Rights: Short-term (30-45 days), exercise price below Current Market Price (CMP), issued to existing shareholders to prevent dilution.
- Warrants: Long-term (2-5+ years), exercise price above Current Market Price (CMP), attached to bonds/preferred stock as 'sweeteners'.
- Both are derivative equity securities that trade independently on secondary markets.
- Exercising rights or warrants increases outstanding shares and dilutes earnings per share (EPS).
Preemptive Rights (Subscription Rights)
Granted pursuant to the preemptive right in corporate charters. Rights are issued to existing common stockholders pro-rata, have short expiration dates (typically 30-45 days), and allow purchasing shares at a discount to the current market price.
Warrants as Debt Sweeteners
Warrants are long-term instruments (often 5 to 10 years or perpetual). At issuance, the strike price is significantly ABOVE the market price. They are bundled with bond offerings to lower the bond's required coupon rate.
| Attribute | Preemptive Rights | Warrants |
|---|---|---|
| Duration | Short-term (30 to 45 days) | Long-term (2 to 5+ years) |
| Exercise Price | Below Current Market Price (Discount) | Above Current Market Price (Premium) |
| Recipient | Existing common stockholders | Purchasers of bonds / preferred stock |
| Purpose | Maintain proportionate ownership | Sweetener to lower borrowing costs |
A corporation plans to issue bonds with attached warrants to finance an expansion. Which of the following statements accurately describes the warrants at the time of issuance?