Question

Common stock versus warrant investment  Personal Finance Problem   Tom Baldwin can invest ​$6,000 in the common stock or the warrants of Lexington Life Insurance. The common stock is currently selling for $25 per share. Its​ warrants, which provide for the purchase of 33 of common stock at ​$22 per​ share, are currently selling for ​$11. The stock is expected to rise to a market price of ​$30 within the next​ year, so the expected theoretical value of a warrant over the next year is ​$24. The expiration date of the warrant is 1 year from the present.

a.  If Mr. Baldwin purchases the​ stock, holds it for 1​ year, and then sells it for ​$30​, what is his total​ gain? ​ (Ignore brokerage fees and​ taxes.)

b.  If Mr. Baldwin purchases the warrants and converts them to common stock in 1​ year, what is his total gain if the market price of common shares is actually ​$30​?​ (Ignore brokerage fees and​ taxes.)

c.  Repeat parts a and b​, assuming that the market price of the stock in 1 year is​ $26.

d. Discuss the two alternatives and the​ trade-offs associated with them.

Answer 1

(a) Number of shares purchased = amount invested/ price per share

= $ 6000/ 25

= 240

Sales consideration after 1 year = No. of shares held X share per after 1 year

=240 X 30

= $ 7200

Total Gain = Sales consideration- Cost of acquision

   = $7,200 - $ 6,000

=$ 1,200