Instalment warrant

[Fab]

Hi,

I am currently willing to invest on ZFX mainly because a big dividend payment is due on the 16/10 and that I think the share price will keep on going up specially during the christmas period therefore in order to benefit of the dividend and possible share increase I am thinking to invest in installment warrant.
My issue is I don't know much about the installment warrant. Could anyone explain me how they work and what are the benefits and risks of it. Starting to how I will get the dividend payment when it comes.

The warrant I am thinking to buy at this stage is ZFXIMH. Please let me know if you think it is not a good one.

Cheers

 

[NettAssets]

Re: Installment warrant

Hi Fab

TFA still has the story on installment warrants on the front page have a look at http://www.fnarena.com/index2.cfm?type=dsp_newsitem&n=FBBDA01A-17A4-1130-F5D1EDA11984ACA3
NA

 

[Magdoran]

Re: Installment warrant

Hello Fab,


Go to:

http://www.asx.com.au/index.htm

In the search area type in “Warrants”, and this will give you a range of links to warrant related documents.

Fab, I say again as I did on the “Options Trader Magazine” thread, please understand that by asking for specific financial advice as you have done twice now, for an evaluation of a specified warrant, anyone responding in a specific and non generic way could potentially be in breech of the law. You are asking posters on this site to take a huge risk, and this isn’t fair on individuals who may not realise the way the new laws work.

Asking about how warrants work is fine. If you ask general questions we can answer them, just not specific ones, OK?

I have taken the time to format the ASX PDF on Warrants on the section dealing with instalment warrants. Also, I gave you the tools to do your own research on the ASX site when I responded to your question on the “Options Trader Magazine” thread. Please go to the ASX site as suggested (please, register for the free online courses – these will really help you to understand how warrants work), or to a qualified derivative expert, or both for more detailed information.

Here is an excerpt from the ASX PDF on Warrants:


Instalment warrants

Instalment warrants give holders the right to buy the underlying instrument (usually securities quoted on ASX) by payment of several instalments during the life of the warrant.

In simple terms, instalments are a loan to buy shares, without the obligation to repay the loan nor the risk of receiving margin calls. The unique feature that sets instalments apart from other types of warrant is that you are entitled to dividends or distributions and franking credits paid by the underlying instrument during the life of the instalment.

It is important to note that in some circumstances holders, although entitled to a dividend, may not actually receive that dividend in cash. For example, special dividends may, subject to the terms of issue, be used to reduce the loan amount rather than paid as cash to the holder. Likewise, holders of ‘Self Funding Instalments’ are entitled to a dividend although they will not receive it as cash as instead they will be directing it be used to reduce the loan amount (see below for details).

Some instalments also pass on voting entitlements of the underlying instrument. Instalments can have a variety of gearing levels. When considered from a gearing perspective, instalments can generally be divided into two categories; ‘regular geared’ and ‘high geared’ instalments. At the time of issue, a ‘regular geared’ instalment will be geared at between 40% and 70%, i.e., for a 50% geared instalment you would pay 50% up front and the warrant issuer ‘lends’ you the remaining 50% (plus interest). At the time of issue, a ‘high geared’ instalment will have a gearing level between 70% and 95%.

By their nature, instalment warrants are call warrants that can be either European or American exercise style and they usually have a life of between 12 months and 10 years. Instalment warrants are usually covered, meaning that the underlying instrument is held in a trust arrangement for your benefit.

On valid exercise and payment of the final instalment, the holder will be entitled to receive the underlying instrument. Some also give you an option to put the underlying instrument back to the issuer and receive a cash payment.

Because an instalment is in essence a loan to buy the underlying instrument, the interest component of the payments may give rise to tax consequences for the holder. As not all instalment warrants have the same structure or features, you should talk to your adviser about the taxation consequences of investing in instalment warrants.


Example
Warrant code NABIOC
Underlying National Australia
instrument Bank ordinary shares
Warrant type Instalment warrant
Expiry date 23 June 2005
Exercise price $20.00
Exercise style American
Settlement Physical delivery


If NAB’s share price was around $31.50 at the time of issue of the warrants then you would have paid about $15.70 for the warrant (about half the share price at the time plus an element of prepaid interest).

You can then pay $20.00 to exercise the instalment any time on or before 23 June 2005 to receive one NAB share per instalment. The relatively conservative gearing level of instalments means that there tends to be a close relationship between movements in instalment warrant prices and movements in the underlying share or other instrument.

There are many different types of instalments that suit a variety of different investors. Below are descriptions of some of these variations and an explanation of the unique features associated with each.

Rolling Instalments

Rolling instalment warrants are a variation on the instalment structure. They have a much longer life (up to 10 years) but each year there is an annual ‘reset date’ when the holder will be charged another 12 months worth of funding costs. At this time the issuer may also adjust the exercise price (often called the “loan amount” of the instalment) with the objective of maintaining a desired gearing level (for example, the exercise price may be adjusted to keep it between 40% and 60% of the current market price of the underlying instrument). The issuer may either;

1. Reduce the exercise price (loan amount). In this case, holders will be asked to make an additional cash payment in order to reduce their loan and prepay their funding costs for the next 12 months.

2. Increase the exercise price (loan amount). In this case the issuer may make a payment to holders equal to the amount of the increase less funding costs for the next 12 months (this may either be in cash or in the form of a reinvestment in additional instalments).

3. Retain the exercise price (loan amount) unchanged. In this case the holder will be required to make a payment to the issuer for the prepayment of funding costs for the next 12 months. On the annual reset date you may choose to exercise some or all of the instalments and take delivery of the underlying securities, cash out the warrant, roll into the following year (by agreeing to pay any additional amounts necessary) or do nothing. If you do nothing you are deemed to have accepted the new exercise price and will automatically roll into the following year. If there is an amount due on a series on the annual ‘reset date’, and you don’t pay this amount, the issuer may terminate some (or all) of your instalments and use the proceeds to meet the amount due. Conceptually, these warrants can be explained as a series of consecutive one year instalment warrants with the exercise price being reset each year.

During the period surrounding each ‘reset date’, investors should take care to consider the effect of a change in the exercise price on the value of the rolling instalment. Information on an upcoming reset can be obtained from the warrant issuer or from ASX.

Self Funding Instalments

Self Funding Instalments (“SFI”) are another variation on the instalment structure. Like other instalments, you make a partial upfront payment and the issuer loans you the remaining amount.

Once you have made your initial payment, generally, there are no additional payments required during the investment term (unless you do not provide your TFN (tax file number) or ABN). SFI’s are moderately geared, with an investment term of approximately 5 years. Holders are entitled to dividends (including franking credits), however the cash component of a dividend will be used to reduce the loan amount rather than being paid in cash to the holder.

The loan amount for a SFI will generally increase once every 12 months, as funding costs are added to the total loan. Hence, over the life of the SFI, the loan amount will periodically decrease due to the payment of dividends from the underlying instrument, and increase by the amount of funding costs. Ideally the loan amount progressively reduces over the life of the SFI due to regular dividend payments exceeding interest and borrowing charges. There may be a number of tax considerations as holders are entitled to dividends (including franking credits) and make interest payments.

As not all instalment warrants have the same structure or features, you should talk to your adviser about the taxation consequences of investing in instalment warrants.

Example
Warrant Code NABIMS
Underlying National Australia Bank
instrument Limited ordinary shares
Expiry date 30 June 2008
Exercise price $17.00
(loan amount) (as at 31 July 2003)
Exercise style American
Conversion Ratio 1:1
Current Price $17.60

In this example, we will consider how an initial $17.00 loan amount for NABIMS will change over a twelve month period. To do this we have assumed that NAB pays fully franked dividends totalling $1.60 over the next twelve month period. We have also assumed that, on 30 June 2004, $1.30 of prepaid interest is charged for the next 12 month period. Taking the dividend assumption into account, the loan amount will initially fall to $15.40 as the $17.00 loan amount is reduced by fully franked dividends of $1.60. However, on 30 June 2004, prepaid interest for the next 12 months of $1.30 is added to the loan amount of NABIMS.

Hence after adding the prepaid interest of $1.30, and taking into account dividends of $1.60, the new loan amount will be $16.70 in 12 months time with the holder also receiving the franking credits attached to the dividends.

Regards


Magdoran

 

[Magdoran]

Re: Installment warrant

Hi,

I am currently willing to invest on ZFX mainly because a big dividend payment is due on the 16/10 and that I think the share price will keep on going up specially during the christmas period therefore in order to benefit of the dividend and possible share increase I am thinking to invest in installment warrant.
My issue is I don't know much about the installment warrant. Could anyone explain me how they work and what are the benefits and risks of it. Starting to how I will get the dividend payment when it comes.

The warrant I am thinking to buy at this stage is ZFXIMH. Please let me know if you think it is not a good one.

Cheers

Hello Fab,

I couldn't fit everything into 1 post since the word limit kicked in...

So, here's the rest:

Ok, a quick set of things to think about when looking at dividend stripping approaches.

Firstly be careful, because the value of many warrants will be adjusted for dividends, and the revaluation happens after the ex-dividend date, and usually the value of call instalment warrants are reduced in value by the issuer to reflect the value of the dividend.

If a stock then continues to fall in value, this can really reduce the value of the warrant. Depending if the warrant strike price is in ITM (in the money, ATM (at the money), or OTM (out of the money), this can greatly effect the value of the warrant depending on the way the stock trends (I suggest that you both access the free online courses available through the ASX to see these effects which the courses cover, and also read up on warrants in detail).

If the warrant is deep in the money, the level of exposure can be higher than at or out of the money series. However the premiums further out of the money can be higher, so beware of this trade off.

Another aspect to consider is time decay. The time value of a warrant falls as it moves towards its expiry date (although this can be a reset date – you need to read up on this). So, depending on how much time value was contained at the time of purchase, even when the underlying stock moves in a favourable direction, the warrant can actually fall in value because the loss in time value can be greater than the gain in the underlying stock. Just be aware of this.

Another risk to consider is that the issuer sets specific conditions for each warrant series, and that the issuer may vary the value of the warrant based on the terms and conditions, so read these carefully. Also, don’t forget that if the issuer becomes insolvent, that this is a real risk with the warrant.

Watch out for the width of the bid and the ask in the actual market if purchasing a warrant here, this can vary. Also beware of things like the ratio of warrants to the underlying, the ratio can have a significant impact on the real value of a warrant, and what appears cheap may not actually be so once you’ve evaluated the warrant.

Also, note that there is a difference between American exercise and European exercise. American exercise allows you to pay the residual value to obtain the shares up and until the expiry date, while European only allows this on the expiry date.


Good luck Fab.


Regards


Magdoran

 

[Fab]

Re: Installment warrant

In an installment warrant is the dividend paid directly to the warrant holder ( in that case myself ??)

 

[NettAssets]

Re: Installment warrant

In an installment warrant is the dividend paid directly to the warrant holder ( in that case myself ??)

Re-read and understand Magdorans posts its all there

Regards
John

 

[Fab]

Re: Installment warrant

How does the 45 days rule works with instalment warrant after earning over $5000 of franking dividend for the financial year.

If hold some shares over 45 days period and other for less than 45 . How do I get tax ?

 

[ozambersand]

Regarding the previous post, there is an article available on the ASX site by Ernst & Young regarding the taxation of warrants. Not all the info is relevant but you will find your answer if you read the article. Broadly speaking, the 45 day rule is the same for instalment warrants as it is for shares as you really "own" the underlying warrant. If you do a cash extraction on those shares within the 45 day period, the position might be different so you better check with a professional!

Getting back to Magdoran's very good explanation I have a couple of other points to make, specifically in regard to trading instalment warrants on-line.

Firstly: Pricing Matrices

As they don't seem to be often traded on-line, the only offers in the buy and sell column are usually the issuer (Macquarie issued warrants are more popular so have a bigger market depth with "real people" taking part) fulfilling their obligation to "make a market".

When it is the issuer fulfilling their obligation to "Create a market at all times" there are a few points to be aware of.

The price they quote for the warrant is as per their pricing matrix, current for that warrant.

Usually these are kept up-to-date and published on the issuer's sites eg:
http://www.macquarie.com.au/wasp/dailytrader/dailytrader_dttradingpickofday_1.htm# for Macquarie or for UBS http://ibol42.ibb.ubs.com/public/in...nstalment&subnav=&bodypage=../iw/iwa_home.jsp

So that you can anticipate what a warrant price should be for a given stock price.

As Magdoran says, this relationship varies depending on how "In-the-money" or "out-of-the-money" they are and whether a dividend has recently been paid etc.

For example, back on March 5th when Zinifex closed at $15.73, an ABNAmro instalment warrant ZFXIZA was priced at $5.56.
Currently Zinifex is trading at $15.72 and ZFXIZA is valued at $5.01!

This reflects the fact that a dividend was paid in the meantime.

The problem is that if you want to sell or buy and base your entry or exit point on a share price you need the pricing matrix to determine what the relative warrant price would be for that underlying share price at that time.

This is why pricing matrices are so important.

Now to my reason for the post!!!!!

ABNAmro has stopped putting pricing matrices on their website. I noticed that they hadn't been updated for two weeks back at the start of April and complained to ABNAmro by email on the 9th April and the next day there were none there and there still aren't, as you can see: http://www.abnamro.com.au/warrants/tools.asp?y=y (as of today (24th April)

I heard third hand that their excuse was that they had a software problem?????

This makes it very difficult to deal in ABNAmro warrants on-line through an E-broker. You can work out a rough matrix by checking Commsec as the share price fluctuates and see how the warrant quoted price changes in relationship and "Do the Math". But it is a pain.

Is anyone else having this problem?

I noticed that ABNAmro doesn't have any new American style warrants and the latest series of non-rolling ones expire in July, so they may not be committed to the whole concept of instalment warrants in general.

Looks like I better use a different issuer!

Secondly: Disappearing "Markets"

Another point to be aware of is that if you lodge a quote for a buy or sell at a particular price using Commsec (for example), the issuer's "market" may disappear when this price looks like it is going to be reached according to the matrix. Theoretically they have to create a market at all times (though I have heard conflcting reports on this) in practice on a couple of occasions I have watched a bid being in which should go because the underlying share price has been reached, but just before it gets there, the "top line - ie the issuer's market" disappears or the number available is ridiculously small.

My solution is to not lodge a bid and just put my bid in when the point has been reached (ie keep the issuer in the dark that a bid will be made). So far I have had success using this strategy, but it means you have to have a couple of windows open at the same time so you can match your bid to the share price as it fluctuates.

It makes it difficult if you can't watch it all the time (which is probably why they recommend going through a broker!!!)

 

[ozambersand]

Well it took ABNAmro a month, but they have finally posted Pricing Matrices for their warrants again.

Mind you someone needs to explain to them where the decimal point should go! Currently all the prices in the matrices are being expressed in cents (not dollars and cents)

They also seem to have forgotten that the fifth letter (I or J) describes whether it is American style or European, as they are describing SHLJZE on the ASX site as being American style rather than European (which the code would imply). It makes a big difference if you want to exercise them prior to expiry.

I know instalment warrants don't seem to be a popular topic on Aussie Stock Forum, but anyone who trades in warrants online would appreciate how difficult it is without accurate information.

In the meantime, I just used Macquarie, UBS and Citigroup which have great warrant sites! :