Beware the Warrants

Current provisions for a too-early exit of the Hellenic Financial Stability Fund from Greek banks risk creating self-reinforcing market dislocations. By offering too many free warrants to private investors, at predetermined exercise prices, share prices of Greek banks could be driven consistently away from fundamentals. That could undermine the smooth transition to full private-sector ownership of the Greek banking system. Spyros Pagratis comments on these issues and suggests policy responses. The full article here.

About S_Pagratis

Athens University of Economics and Business

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2 Responses to Beware the Warrants

  1. Stratos Manolas says:

    Well done Spyros very good analysis
    will the market though be gully aware of this and all depends how many will exercise
    early versus later on , and what state will the market be at the time most people want
    to realise their profits .The more people exersise early the less warrants will be available for later on for exercise ,that might smooth out any steep price increases.
    Anyways the HFSF seem to agree to this schedule as my undestanding is that the
    exercised shared wil come out of their own shareholdings.

  2. Spyros Pagratis says:

    In the numerical example I offered, the paradox of an ever increasing stock price is generated by the fact that the intrinsic value of warrants is not zero, but equal to 0.22. That generates the extra value of 2*0.22=0.44 per share, beyond the initially assumed share price of 1.

    In order to solve the paradox, the value of warrants (net of any cost) should be equal to zero. For that to be the case, Cabinet Act 38 should not set the exercise price of warrants close to the offer price of the capital increase (0.45 in my example), but, instead, equal to the closing price of the stock the last day of exercising the rights (0.63 in my example). That would set the implicit ex-warrants price of the stock equal to the exercise price of warrants, thus the intrinsic value of warrants equal to zero:

    p=[3*0.63+2*7.33*p]/[3+2*7.33] => p=0.63

    Alternatively, if the exercise price of warrants is set close to the offer price of new shares, then private investors should not get them for free, but at a costs. In my example, the HFSF should offer them at a cost of Euro 0.22 per warrant. Otherwise, the HFSF is offering a free lunch of few billion euros to investors that participate in the capital increase, which generates the paradox.

    In the example, the value transfer from the public sector to private investors is Euro 0.44 for each existing share (i.e. before the capital increase). Multiply this by the total number of existing shares and you get the total value-transfer from the HFSF to private investors.

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