The Gifford Investment Company bought 90 Cable Corporation warrants one year ago and would like to exercise them today. The warrants were purchased at \(25 each and expire when trading ends today. (Assume there is no speculative premium left.) Cable Corporation common stock was selling for \)49 per share when Gifford Investment Company bought the warrants. The exercise price is \(41, and each warrant entitles the holder to purchase two shares of stock, each at the exercise price.

1. What was the intrinsic value of a warrant at that time?
2. What was the speculative premium per warrant when the warrants were purchased? The purchase price, as indicated earlier, was \)25.
3. What would Gifford’s total dollar profit or loss have been had it invested the \(2,250 directly in Cable Corporation’s common stock one year ago at \)49 per share? Cable Corporation common stock is selling today for \(59 per share.
4. What would the percentage rate of return be on this common stock investment? Compare this to the rate of return on the warrant computed when the common stock was selling for \)59 per share.

The sort of stock most people invest in is a common stock, which represents a portion of proprietorship in a business. The common stock also comes with voting rights in expanding the potential for dividends and capital growth. A company's balance sheet in bookkeeping contains details on its common shares.

$\begin{array}{rcl}\mathit{I}\mathit{n}\mathit{t}\mathit{r}\mathit{i}\mathit{n}\mathit{s}\mathit{i}\mathit{c}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}& \mathbf{=}& \left(Stockprice-Exerciseprice\right)\mathbf{\times }\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\\ & \mathbf{=}& \left(\$49-\$41\right)\mathbf{\times }\mathbf{2}\\ & \mathbf{=}& \mathbf{\$}\mathbf{16}\\ & & \end{array}$

$\begin{array}{rcl}\mathit{S}\mathit{p}\mathit{e}\mathit{c}\mathit{u}\mathit{l}\mathit{a}\mathit{t}\mathit{i}\mathit{v}\mathit{e}\mathbf{}\mathit{p}\mathit{r}\mathit{e}\mathit{m}\mathit{i}\mathit{u}\mathit{m}\mathbf{}\mathit{p}\mathit{e}\mathit{r}\mathbf{}\mathit{w}\mathit{a}\mathit{r}\mathit{r}\mathit{a}\mathit{n}\mathit{t}& \mathbf{=}& \mathit{P}\mathit{u}\mathit{r}\mathit{c}\mathit{h}\mathit{a}\mathit{s}\mathit{e}\mathbf{}\mathit{p}\mathit{r}\mathit{i}\mathit{c}\mathit{e}\mathbf{-}\mathit{I}\mathit{n}\mathit{t}\mathit{r}\mathit{i}\mathit{n}\mathit{s}\mathit{i}\mathit{c}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\\ & \mathbf{=}& \mathbf{\$}\mathbf{25}\mathbf{-}\mathbf{\$}\mathbf{16}\\ & \mathbf{=}& \mathbf{\$}\mathbf{9}\\ & & \end{array}$

Computing value of shares

$\begin{array}{rcl}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}& \mathbf{=}& \frac{\mathbf{I}\mathbf{n}\mathbf{v}\mathbf{e}\mathbf{s}\mathbf{t}\mathbf{m}\mathbf{e}\mathbf{n}\mathbf{t}}{\mathbf{P}\mathbf{e}\mathbf{r}\mathbf{}\mathbf{s}\mathbf{h}\mathbf{a}\mathbf{r}\mathbf{e}\mathbf{}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{250}}{\mathbf{\$}\mathbf{49}}\\ & \mathbf{=}& \mathbf{46}\mathbf{}\\ & & \end{array}$

Computing total dollar profit or loss

$\begin{array}{rcl}\mathit{T}\mathit{o}\mathit{t}\mathit{a}\mathit{l}\mathbf{}\mathit{d}\mathit{o}\mathit{l}\mathit{l}\mathit{a}\mathit{r}\mathbf{}\mathit{p}\mathit{r}\mathit{o}\mathit{f}\mathit{i}\mathit{t}\mathbf{}\mathit{o}\mathit{r}\mathbf{}\mathit{l}\mathit{o}\mathit{s}\mathit{s}& \mathbf{=}& \mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{\times }\left(Todayrate- Previouscommonstockrate\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{46}\mathbf{\times }\left(\$59-\$49\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{460}\\ & & \end{array}$

Calculation of Intrinsic value of warrant

Calculation of proceeds from the sale

$\begin{array}{rcl}\mathit{P}\mathit{r}\mathit{o}\mathit{c}\mathit{e}\mathit{e}\mathit{d}\mathit{s}\mathbf{}\mathit{f}\mathit{r}\mathit{o}\mathit{m}\mathbf{}\mathit{s}\mathit{a}\mathit{l}\mathit{e}& \mathbf{=}& \mathit{I}\mathit{n}\mathit{t}\mathit{r}\mathit{i}\mathit{n}\mathit{s}\mathit{i}\mathit{c}\mathbf{}\mathit{v}\mathit{a}\mathit{l}\mathit{u}\mathit{e}\mathbf{\times }\mathit{W}\mathit{a}\mathit{r}\mathit{r}\mathit{a}\mathit{n}\mathit{t}\mathit{s}\\ & \mathbf{=}& \mathbf{\$}\mathbf{36}\mathbf{\times }\mathbf{90}\\ & \mathbf{=}& \mathbf{\$}\mathbf{3}\mathbf{,}\mathbf{240}\\ & & \end{array}$

Calculation of Purchase price

$\begin{array}{rcl}\mathit{P}\mathit{u}\mathit{r}\mathit{c}\mathit{h}\mathit{a}\mathit{s}\mathit{e}\mathbf{}\mathit{p}\mathit{r}\mathit{i}\mathit{c}\mathit{e}& \mathbf{=}& \mathit{W}\mathit{a}\mathit{r}\mathit{r}\mathit{a}\mathit{n}\mathit{t}\mathit{s}\mathbf{\times }\mathit{P}\mathit{r}\mathit{i}\mathit{c}\mathit{e}\\ & \mathbf{=}& \mathbf{90}\mathbf{\times }\mathbf{\$}\mathbf{25}\\ & \mathbf{=}& \mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{250}\\ & & \end{array}$

Calculation of profit

$\begin{array}{rcl}\mathit{P}\mathit{r}\mathit{o}\mathit{f}\mathit{i}\mathit{t}& \mathbf{=}& \mathit{P}\mathit{r}\mathit{o}\mathit{c}\mathit{e}\mathit{e}\mathit{d}\mathit{s}\mathbf{}\mathit{f}\mathit{r}\mathit{o}\mathit{m}\mathbf{}\mathit{s}\mathit{a}\mathit{l}\mathit{e}\mathbf{-}\mathit{P}\mathit{u}\mathit{r}\mathit{c}\mathit{h}\mathit{a}\mathit{s}\mathit{e}\mathbf{}\mathit{p}\mathit{r}\mathit{i}\mathit{c}\mathit{e}\\ & \mathbf{=}& \mathbf{\$}\mathbf{3}\mathbf{,}\mathbf{240}\mathbf{-}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{250}\\ & \mathbf{=}& \mathbf{\$}\mathbf{990}\\ & & \end{array}$

Calculation of return

$\begin{array}{rcl}\mathit{R}\mathit{e}\mathit{t}\mathit{u}\mathit{r}\mathit{n}& \mathbf{=}& \frac{\mathbf{P}\mathbf{r}\mathbf{o}\mathbf{f}\mathbf{i}\mathbf{t}}{\mathbf{P}\mathbf{u}\mathbf{r}\mathbf{c}\mathbf{h}\mathbf{a}\mathbf{s}\mathbf{e}\mathbf{ }\mathbf{p}\mathbf{r}\mathbf{i}\mathbf{c}\mathbf{e}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{990}}{\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{250}}\\ & \mathbf{=}& \mathbf{44}\mathbf{.}\mathbf{00}\mathbf{\%}\\ & & \end{array}$

$\begin{array}{rcl}\mathit{R}\mathit{e}\mathit{t}\mathit{u}\mathit{r}\mathit{n}& \mathbf{=}& \frac{\mathbf{P}\mathbf{r}\mathbf{o}\mathbf{f}\mathbf{i}\mathbf{t}}{\mathbf{P}\mathbf{u}\mathbf{r}\mathbf{c}\mathbf{h}\mathbf{a}\mathbf{s}\mathbf{e}\mathbf{ }\mathbf{p}\mathbf{r}\mathbf{i}\mathbf{c}\mathbf{e}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{460}}{\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{250}}\\ & \mathbf{=}& \mathbf{20}\mathbf{.}\mathbf{44}\mathbf{\%}\\ & & \end{array}$

The rate of return of the warrant while the selling price is $59 is less than the 44.00% return on the warrant.