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while not exactly stocks, are directly based on stocks or are otherwise traded in stock
markets. Or, they are derived from stocks. Because of these characteristics, such products
are often referred to as derivatives (derived from derivatives, get it?). Here are the various
types of derivatives:
Subscription rights
Warrants
Options
Calls
Puts
Stock index options
Since derivatives generally require more expertise and are substantially more volatile than
simple stock transactions, newer investors often avoid them. These same characteristics,
however, are the main reasons why derivatives are particularly popular both with seasoned
experts having substantial sums and with adventurous new investors who have yet to grow
their portfolios.
I l@ve RuBoard
I l@ve RuBoard
Subscription Rights
Subscription rights are formalized promises from a company to sell its stock to its current
stockholders at a price reduced from the market price in the event of new stock being issued.
Plain English
Subscription rights are a type of financial instrument that a company grants to its
current shareholders, giving them the option to buy future issues of company stock
at a discount price.
For example, let's say you own 100 shares of XYZ Company for which you paid $8 per share.
XYZ Company issued only 200 shares to begin with, so you effectively bought and own half
of XYZ Company. Now the price of XYZ Company has risen to $10 per share, and XYZ
Company decides that it wants to raise some more cash to open a new Widget factory in a
nearby town. So, the company offers another 200 shares of stock for sale. Your half-
ownership of XYZ Company has been effectively cut to one-fourth with the stroke of a pen.
"That's not fair," you cry. "I bought those 100 shares initially so that I could have half-
ownership in the company."
XYZ Company certainly doesn't want to cause hard feelings in those people who already own
its stock, because a sell-off by angry shareholders could lower the price of the stock, and the
company would thereby effectively lose all the money it had stood to gain by issuing new
stock.
To address this type of situation, XYZ Company decides to issue subscription rights to its
current shareholders. By issuing subscription rights, XYZ Company gives its investors
"coupons" with which they can buy shares of the newly issued 200 shares for $8 per share
rather than the $10 everyone else has to pay. These coupons, or subscription rights, are
usually issued based on the number of shares already held by the current investor. In the
same example, you own 100 shares, and XYZ Company has decided that for every 5 shares
held by a current investor the investor will be issued one subscription right. You therefore
have the right to purchase 20 shares for $8 each.
If you buy 20 additional shares at $8, it will cost you $160. That's a big break from the $200 it
would cost a new investor to purchase those same 20 shares at $10 per share. And the value
of your new shares is still $200, just as if you had paid the new-investor price of $10 per
share. Thus you immediately make $40.
Immediate Gratification
The advantage of subscription rights is that you can make money from them even if you have
no interest in purchasing additional stock. Let's say XYZ issues you 20 subscription rights
and, truthfully, you have no intention of using them. Then let's say I'm an investor who wishes
to purchase XYZ Company stock. You offer to sell me your 20 subscription rights for $1 each.
Yes, you can do that because subscription rights are fully transferable; in other words, you
can use them or dispose of them as you see fit.
I pay you $20 for your subscription rights and then buy the 20 shares at $8 each (20 × $8 =
$160). Adding in the $20 I paid you initially, my total price is $180. I still got the stock $20
cheaper than if I had bought it in the open market at $10 per share. You've just made $20
from selling me something you didn't want anyway. As this example shows, subscription
rights are really popular. They're like getting an unexpected gift. You are, however, still no
longer half-owner in XYZ Company, but then it's not a perfect world.
I l@ve RuBoard
I l@ve RuBoard
Warrants
Warrants are very much like subscription rights in that they are usually used to purchase
stock for less than what the stock is currently worth, or the current market value. Warrants
differ from subscription rights in that subscription rights entitle the bearer to deduct a certain
amount from the price of the stock, whereas warrants entitle the bearer to purchase the stock
at a predetermined price, regardless of the current price the stock is selling for on the open
market.
Plain English
Warrants are a type of financial instrument distributed by the company that
originally issued the corresponding stock. The warrants grant the bearer the right to
purchase that company's stock at a predetermined price, regardless of the market
value of the stock at that time.
For example, suppose that you have just purchased 10 shares of XYZ Company stock at $10
per share. XYZ Company knows that, as a new company, it may have a little difficulty finding
new investors in the market right now, so the company attaches a warrant to each share that
you have just purchased (free of charge, no less). The warrant entitles you to buy a share of
XYZ Company stock for $11, regardless of what it's selling for on the market. Since you have
just bought the stock for $10 per share, it would be kind of silly to pay $11 per share right
now.
But, in the course of time, the price of XYZ Company rises to $13 per share. By cashing in
your warrants, you could buy 10 more shares of XYZ Company stock at the price of $11 per
share, thereby making an immediate profit of $20 ($11 × 10 = $110, versus $13 × 10 =
$130).
Let's say that when you purchased those 10 initial shares and received the warrants, you
were satisfied because you really only wanted 10 shares to begin with. You figured the
warrants were nice but relatively useless, right? No. As in the subscription rights example,
you can sell or otherwise dispose of warrants however you see fit. Therefore, if the price of
XYZ Company stock rises to $13 per share, you have 10 warrants to use for purchasing that
stock at $11 per share.
I'm an investor who wants to purchase XYZ Company stock, so you offer to sell me your
warrants for $1 each. I use your warrants to purchase XYZ Company stock at $11 per share,
and I still save $10 ($11 × 10 = 110 + $10 = $120, versus $13 × 10 = $130). You've just
made $10 by selling me something you didn't want to begin with, and XYX Company has
attracted a new investor. Everybody's happy.
More on Warrants
Many investors buy and sell warrants, completely ignoring the underlying stock, because
oftentimes more money can be made from the warrant transactions. For example, let's say
you bought those 10 warrants from me at $1 each. Instead of using them to buy stock, you
hold on to them and wait until the price of XYZ Company stock climbs to $14 per share. You
then find another investor who is willing to pay $2 per warrant. The advantage to the buyer is
that he or she acquires the right to buy XYZ Company shares at the bargain price of $11
each. The buyer will still save $10 in the transaction ($2 × 10 warrants = $20 and $11 × 10
shares = $110; $20 + $110 = $130, versus $140 to purchase 10 shares at $14). The investor
has saved money, and you have made $10 from your initial $10 investment, effectively giving
you a 100-percent profit.
Of course, if the price of XYZ Company stock never rises above $11 per share, you've just
bought a dog with fleas. Welcome to the wonderful world of investing. [ Pobierz całość w formacie PDF ]

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