Understanding Call Warrants

Transcription

1 Understanding Call Warrants Contents Disclaimer Introduction Warrants Features of Call Warrants Call Warrants Issued in Malaysia Terms and Conditions of Call Warrants Exercising Call Warrants Adjustments Trading Call Warrants Settlement of Transactions in Call Warrants Suspension/Delisting of Underlying Shares Pricing of Call Warrants Risks What You are Entitled to Receive from your Stockbroker Glossary of terms

2 Disclaimer This document does not constitute a recommendation to buy or sell securities. It is intended for your general information only. It does not contain exhaustive advice or information relating to the subject matter of the booklet. Nor should it be used as a substitute for legal or investment advice. If in doubt, investors are strongly recommended to seek professional advice with regard to the risks associated with investing in call warrants before buying or selling any warrants. While care has been taken in the preparation of this booklet, the Securities Commission does not take any responsibility for any inaccuracy or incompleteness of the information contained in this booklet. Understanding Call Warrants This booklet has been put together by the Securities Commission. It contains a description of call warrants and some additional information on the call warrants listed and traded on the Kuala Lumpur Stock Exchange as well as risks of which a prospective investor in call warrants should be aware. At the end of this booklet is a glossary of terms which should be referred to as a guide to reading and understanding its contents. If you have any further questions relating to call warrants or your rights and obligations should you invest in call warrants, please consult your stockbroker or other relevant professional adviser first. If your stockbroker or adviser cannot give you the information you seek, you may call the Corporate Affairs Department of the Securities Commission who will try to address your enquiries. Warrants A warrant is an option that is typically offered by an institution and may be subsequently listed and traded on an exchange. There are two types of warrants: call warrants and put warrants. A call warrant gives a right, but not an obligation, to, buy a fixed quantity of an asset (such as shares) for a specified price within a limited period of time. A put warrant gives a right, but not an obligation, to sell a fixed quantity of an asset for a specified price within a limited period of time. The information contained in this booklet relates to call warrants based on shares. Features of Call Warrants There are three defining features of a call warrant - a. Underlying Asset A call warrant is issued on an underlying asset such as shares of a company. It gives the holder the right, but not the obligation, to buy from the issuer a specified number of shares in the underlying company at an agreed price by or at a future date. b. Exercise Price This is the price at which the call warrants holder may choose to exercise the right to buy the underlying shares. This is price is fixed at the time of the issue of the warrant.

3 c. Exercise Period A call warrant may only be exercised within a limited period at the end of which the warrant will expire. The date of expiry of the warrant is also known as the "maturity date". There are two types of exercise style: American and European. American style allows the holder to exercise at any time up to and including the maturity date; European style warrants may only be exercised on the maturity date. Call Warrants Issued in Malaysia On 6 December 1994, the Securities Commission released its guidelines for the issue of call warrants ("Guidelines"). Under the Guidelines, call warrants issued or offered in Malaysia must meet at least the following conditions. Underlying shares Call warrants can only be issued in respect of shares issued in the capital of a listed company that has:?? a minimum average daily market capitalisation of RM2 billion continuously for three months before the date of issue;?? a minimum average monthly turnover of 2 million shares traded in the past 12 months;?? a minimum number of 2,000 registered shareholders;?? a 5-year uninterrupted after-tax profit record; and?? a minimum of 100 million shares in public float. Exercise style Call warrants must have an American style exercise. Other terms The call warrants will be issued on the basis that one warrant will be exerciseable in respect of one share (subject to adjustment to entitlements referred to below). On exercise of the warrants, issuers have the option to deliver shares or pay a cash sum in settlement have the option to deliver shares or pay a cash sum in the settlement of their obligations. If an issuer elects to pay a cash sum, that sum has to be the difference between the exercise price and the higher of:?? the market value of the shares on the date preceding the date of exercise; or?? the average closing price per share over the period of thirty market days preceding the date of exercise. Call warrants will be issued on a registered basis. The registrar will be a company appointed by the issuer to record all transfers of call warrants and issue certificates to warrantholders. The time required for registering any transfer should not exceed five market days.

4 Adjustment of entitlements The exercise price and the entitlements of warrantholders are subject to adjustments in the circumstances described under the heading ADJUSTMENTS in this booklet. Terms and Conditions of Call Warrants The terms and conditions of the call warrants will be set out in an instrument executed by the issuer in favour of warrantholders. Certain convenants of the issuer in respect of the call warrants will also be held by a trustee for the benefit of warrantholders. Warrantholders may inspect the trust deed and would be deemed to have notice of the terms and conditions of issue and the provisions of the trust deed. Salient terms and conditions of the call warrants will be highlighted by the issuer in the prospectus. All prospective warrantholders are advised to read and understand the terms and conditions of the call warrants. In the interests of facilitating investment and understanding of the terms of call warrants, the Securities Commission has required standardisation of many key terms and conditions of issue to the extent practicable. A summary of some of those terms is given below. A warrantholder requiring clarification on the terms and conditions of the call warrants should consult in his/her stockbroker or adviser. Exercising Call Warrants If a warrantholder wishes to exercise his call warrants, the warrant certificate must be registered in his name. The call warrants are exerciseable only in intergral multiples of 1,000 warrants (subject to a smaller number as the Commission may determine). The warrantholder would be required to deliver a completed exercise notice and attach paymnet of the exercise price to the registrar. The issue will notify the warrantholder in writing not later than five market days after the exercise date if settlement is to involve the payment of a cash sum instead of delivery of the underlying shares. The issuer would then be obliged to pay cash or deliver within 10 market days the share certificates in relation to the underlying shares together with duly executed transfer forms. Adjustments Adjustments will be made by the issuer to the exercise price and/or the number of underlying shares in the following circumstances:?? Rights Issue The exercise price and the number of underlying shares may be adjusted accordingly for rights issues provided that no adjustment will be made for issues that result in a change in the market value of shares of less than three percent (3%).?? Bonus Issue

5 The exercise price and the number of underlying shares may be adjusted accordingly for bonus issues provided that no adjustment will be made for issues that result in a change in the market value of shares of less than three percent (3%).?? Share Splits or Consolidation The issuer must also adjust the number of underlying shares and the exercise price in the event of share splits or consolidations. Other Adjustments Adjustments may be made in other circumstances not described above. Such adjustments have to be made by the issuer in a fair and equitable manner after consultation with a licensed merchant bank. Trading Call Warrants As call warrants are listed and quoted on the Kuala Lumpur Stock Exchange, the trading process and the brokerage fee levied are similar to that applicable to other listed equity securities. Call warrants are transferable in integral multiples of 1,000 by delivery of a transfer form for registration to the registrar together with the warrant certificate(s) and payment of such fees as may be charged by the registrar. Settlement of Transactions in Call Warrants Any sale or purchase of call warrants listed on the Kuala Lumpur Stock Exchange will be settled through the fixed delivery and settlement system (FDSS) operated by SCANS in the same manner as transactions in shares are currently settled. On the occurrence of a settlement disruption event (i.e. an event that is beyond the control of the issuer as a result of which the issuer is unable to deliver the underlying shares pursuant to the exercise of the call warrants) the issuer may deliver the shares in such other commercially reasonable manner as the issuer considers appropriate or the delivery of such underlying shares may be postponed. Suspension/Delisting of Underlying Shares If a warrantholder exercises a warrant at a time when trading of the underlying shares on the stock exchange is suspended and the issuer is unable to deliver shares as settlement, the warrantholder will be taken to have exercised the warrant on the first market day after the suspension has been lifted. Suspension of the trading of underlying shares may extend beyond the stated maturity date resulting in the exercise period being extended until the suspension has ended. Should the underlying shares be removed from the official list of the stock exchange, the issuer may make necessary adjustments to the rights attached to the call warrants after consultation with a licensed merchant bank.

6 Pricing of Call Warrants The price of a call warrant is known as the premium. While the exercise price of a warrant remains fixed (subject to adjustments), the premium is variable. It reflects the value of the warrant at any point in time. There are a number of factors influencing the premium value of a warrant: Risks?? Underlying Share Price The market price of the underlying share is the most significant factor affecting the premium of a warrant. A higher market price will be reflected in a higher premium.?? Volatility Volatility measures the fluctuation in the market price of the underlying stock over a given period. The higher the volatility of the underlying stock, the higher the premium value of the call warrants, as it has a greater chance of placing the warrant in-themoney.?? Time Remaining Until Expiration The longer the period to expiration, the higher the premium value, as there is a longer time for the share price to move in the right direction to place the warrant in-the-money.?? Dividends A cash dividend normally lowers the share price on the ex-dividend date. This will cause the premium for a call warrant to be less valuable.?? Interest Rates Higher interest rates are likely to lead to higher premiums for call warrants. It is in the interest of warrantholders to acquaint themselves with the risks associated with call warrants before investing. The following is not an exhaustive list of the relevant risks but contains a description of some of the important risks encountered by a warrantholder. Market risk Warrantholders will only start to make a profit from investing in call warrants if the price of the underlying shares has increased by an amount which exceeds the price (also known as the option premium) paid for the warrant plus transaction costs and interest charges, if any. Warrantholders should note that the price of call warrants may fall in value as rapidly as it may rise. If the price of the underlying shares falls below the exercise price at the maturity of the warrants, then warrantholders will sustain a total loss of their investment. However, this loss is limited to the price paid for the warrant and transactions costs.

7 The following is a profit and loss diagram related to an investment in a call warrant at the maturity date where the premium paid is RM3 and the exercise price is RM12. In the example, a profit is made only if the share price exceeds RM15. The profit is defined as [share price - (exercise price + premium)]. If the share price is between RM12 and RM15, the warrantholder, upon exercise, will realise a loss somewhere between 0 and RM3. Exercise risk If the warrants mature in-the-money, warrantholders should note that it is necessary for them to pay the exercise price of the warrants before they are able to received from the issuer the underlying shares or settlement in cash under the terms of the cash alternative exerciseable by the issuer. If a warrantholder holds a warrant until maturity and the warrant is in-the-money, the warrantholder must exercise the warrant to realise any value attached to the warrant. If the warrant is unexercised, that value will be lost after the maturity date. Credit risk The call warrants will constitue general unsecured obligations of the issuer. When call warrants are purchased, warrantholders are relying on the creditworthiness of the issuer, i.e. the ability of the issuer to make good on its financial obligations if the warrants are in-the-money. Warrantholders do not have any rights whatsoever against the underlying company. Each issue of call warrants is accompanied by a prospectus which contains material information relating to the underlying shares, the rights and obligations of warrantholders and the issuer and financial information relating to the issuer and risk manager, if any. Prospective warrantholders should study the information contained in the prospectus carefully before making an investment decision. What You are Entitled to Receive from your Stockbroker Stockbroking companies must provide a risk disclosure statement to a client and obtain his/her signature before executing the first instruction from that client to trade in call warrants. They should also take reasonable steps to give their clients in a clear and timely manner any information needed to enable them to make a balanced and informed decision.

8 Glossary of terms Call warrant or warrant means a right to buy a specified number of shares, exerciseable against the issuer of the right on or before a predetermined future date. Exercise price means the price payable by the warrantholder on the exercise of his/her right under a call warrant. In-the-money refers to a warrant which has an intrinsic value. Intrinsic value means the positive value derived from subtracting the exercise price from the share price. Issuer in relation to a warrant, means the entity that has issued the warrant. Maturity date means the last day on which the holder may exercise his/her right under a call warrant. The terms mature and maturity have corresponding meanings. Out-of-the-money refers to a warrant which has no intrinsic value. Risk manager means a company that has contracted with an issuer to hedge the issuer's market exposure resulting from the issuer having issued call warrants. Underlying company means a company listed on the Kuala Lumpur Stock Exchange of whose capital the underlying shares from part. Underlying shares means the shares which are the subject of a call warrant. Warrantholder or holder means the person or persons registered as the owner of a warrant.