Exploring the Unique Characteristics of Equity Warrant Bonds

Equity warrant bonds are a unique financial instrument that combines the characteristics of bonds with the flexibility of equity warrants. These bonds are issued with equity warrants attached, which are similar to share options. The holder of the warrant has the right, but not the obligation, to subscribe for a fixed quantity of equity stocks in the company at a future date and at a fixed subscription price, known as the exercise price. One of the key features of equity warrant bonds is that the warrants are detachable and can be traded separately from the bonds on the stock market.

Investors are attracted to equity warrant bonds because they offer the potential for capital appreciation through the warrants while also providing a fixed income stream from the bond coupon payments. This dual benefit makes equity warrant bonds an attractive investment option for those seeking both income and growth potential. Investors may choose to hold the bonds to maturity as a long-term investment and sell the warrants in the market shortly after purchase to capitalize on any price movements.

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Unlike traditional bonds, equity warrant bonds are unsecured and typically offer a lower coupon rate of interest compared to similar straight bonds issued by the same company. This lower interest rate is a trade-off for the potential upside from the equity warrants. Additionally, if the warrants are exercised, the company can use the proceeds from issuing new stocks to help redeem the bonds, effectively replacing debt capital with new equity.

Historically, equity warrant bonds gained popularity in the late 1980s, particularly in Japan, where companies used them to raise capital in the euro convertibles market.

These bonds typically had a five-year term, with the warrants exercisable at maturity. However, the collapse of Japanese share prices in 1989 led to many of the warrants becoming worthless as their exercise price exceeded the current share price.

As these equity warrant bond issues matured in the mid-1990s, companies faced the challenge of redeeming the bonds with limited cash on hand. Some companies were able to issue new equity warrant bonds at low share prices, using the proceeds to redeem the maturing debt. This unique cycle of issuing new equity warrant bonds to redeem existing ones highlights the flexibility and adaptability of this financial instrument.

Despite their initial popularity, equity warrant bonds have not regained widespread appeal since the late 1980s. In the late 1990s, they found niche interest in countries like Germany and Switzerland, where investors valued their unique characteristics. Another trend that emerged in the late 1990s was the rise of the exchangeable market, where bonds could be redeemed in another company's stocks, allowing for strategic divestments.

In countries like France and Japan, where corporate cross-holdings are common, derivatives such as equity warrant bonds provide a more efficient way to rationalize these holdings without flooding the market with shares. Additionally, the tax treatment of convertible bonds and equity warrant bonds makes them attractive to companies, as the interest payments are usually tax-deductible, reducing the after-tax cost of borrowing.

Overall, equity warrant bonds represent a unique hybrid of debt and equity financing that offers investors the opportunity for capital appreciation and companies the flexibility to manage their capital structure effectively. While their popularity may have waned over the years, these financial instruments continue to have a place in specialized markets where their distinctive features are valued.

References

• Moody's - Equity Linked Bonds
• J.P. Morgan - Insights on Equity Linked Bonds
• Bloomberg - Understanding Equity Linked Bonds