New issues

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11. A word on warrants

Some investment trusts try to attract investors at launch by bundling 'free' warrants together with each allocation of ordinary shares. As usual, there is a catch, but in this case, it is relatively minor. Thanks to the 'free' warrants, the trust is often able to set the issue price at a slight premium to net asset value. Once issued, the shares of most trusts are likely to trade at a discount for most of the time. So you could well end up paying for this 'free' offer!

Less experienced investors are sometimes uncertain about what to do with their warrants. The short answer is nothing. A warrant is exactly like a long-dated call option. It gives you the right, but not the obligation, to buy one - or sometimes more - shares, at a certain price between certain specified dates. The final or 'expiry' date is usually set around 2-5 years after launch. The price is known as the 'exercise price'.

If the share price rises well above the exercise price before expiry, it will clearly be to your advantage to exercise your right to purchase the shares. If the share price remains below the exercise price, the warrants will expire worthless.

Warrants are quoted separately from their associated shares. They can also be bought and sold separately. Since their value is linked to the underlying share price, it will fluctuate according to investors' expectations of where the share price is heading.

Novices are often amazed at how much more violently warrant prices move around than share prices. The explanation lies in 'gearing'. This means that warrants offers the potential for greater percentage gains and losses than the shares, because of their lower price. For the same money, you can control a much larger amount of shares by buying warrants than by buying the shares themselves. For example:

Speculators get very excited by the possibilities of warrants. But it would be foolish to try and buy large quantities of a new issue simply to get your hands on the 'free' warrants. For one thing, you may have to pay a premium for the trust's shares. For another, if your allocation is scaled down, you could end up such a pitifully small number of warrants that the commission on selling them wipes out your profit.

If you are tempted to add to your holding of warrants in the open market, you need to bear in mind the high risks associated with dealing in this type of asset:

• Spreads are often very high
• Normal market sizes are often very low
• Low liquidity means that your own dealing may often cause prices to move against you.

In general, warrants are best left to the professionals, until you have enough experience to judge the prospects for the underlying shares. For more information on warrants, you can visit tipsheets.co.uk. This site was founded by Andrew McHattie, author of The Investor's Guide to Warrants and the newsletter Warrants Alert.

1. After Sid - a short history of the new issues market 2. Do new issues offer good value? 3. Types of new issue 4. Applying via brokers and intermediaries 5. The prospectus 6. What to look for in the prospectus (1) - directors and advisers 7. What to look for in the prospectus (2) - standard company analysis 8. What to look for in the prospectus (3) - blue-sky company analysis 9. Making your application 10. Stagging 11. A word on warrants 12. A tale of two issues 13. Conclusion

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