Canadian Securities Course (CSC) Level 1 Practice Exam

Why do investors buy warrants?

1. To speculate on future stock prices.

2. To hedge against potential losses.

3. To leverage their potential gains since the market price of a warrant is usually much lower than the price of the underlying security.

4. To gain control over the issuing company.

The correct answer is: To leverage their potential gains since the market price of a warrant is usually much lower than the price of the underlying security.

Investors buy warrants primarily to leverage their potential gains, which is why the correct answer focuses on this aspect. Warrants are long-term instruments that allow the holder to purchase shares of an underlying security at a predetermined price, known as the exercise price. Because warrants are often issued at prices significantly lower than the market price of the underlying security, they provide an opportunity for substantial returns if the stock's price rises above the exercise price. This leveraged potential is appealing to investors, as it allows them to control more shares with a smaller investment compared to directly purchasing the underlying stock. If an investor believes that the price of the underlying security will increase significantly in the future, buying warrants can yield higher percentage gains on their initial investment compared to owning the stock outright. This is particularly attractive in bull markets or when investors anticipate growth in a company's stock. While speculation on future stock prices and hedging against potential losses might seem relevant, they do not capture the unique leveraging potential that warrants offer. Gaining control over the issuing company is also not directly applicable, as ownership and control typically require holding shares rather than warrants, which do not confer voting rights or equity ownership until exercised.