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An introductory guide
WARRANTS &
CERTIFICATES2002
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CONTENTS01. WHAT ARE WARRANTS
& CERTIFICATES? 02Warrants 03
Certificates 03
02. WHY CONSIDER WARRANTS& CERTIFICATES? 04Global product range 05
Sterling denominated, locally traded 05No stamp duty 05
Enables multiple investment strategies 05
Regulated, liquid and transparent market 05
Limited liability 05
03. HOW CAN WARRANTS& CERTIFICATES BE USED? 06Leveraged investing 08
Hedging a position or portfolio with warrants 09
Extracting cash 10
Diversification using certificates 10
Asset allocation 10
Trading warrants 11
04. HOW ARE WARRANTS PRICED? 12Intrinsic value 13
Time value 14
Factors determining a warrant price 15
Underlying asset price 16
Strike price 16
Time to expiry 16
Volatility 16
Risk-free rate of interest 17
Dividend expectations 17
05. HOW DO WARRANTS &CERTIFICATES DIFFER FROM OTHERUK INVESTMENT PRODUCTS? 18
06. WHY GOLDMAN SACHS? 21Goldman Sachs at a glance 23
07. WARRANTS AND CERTIFICATESGLOSSARY 24
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01.WHAT AREWARRANTS &CERTIFICATES?Warrants
Certificates
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WHAT ARE WARRANTS AND CERTIFICATES?
The London Stock Exchange has launched a new
range of products for UK investors warrants and
certificates. For years these products have been
widely popular in continental European markets
due to their high return potential and their ability
to offer positive returns in both rising and falling
markets. Available in the UK for the first time,
following their release in autumn 2002, these new
securities could play a significant role in UK
investment portfolios.
The following pages offer an introduction towarrants and certificates, outlining some key stra-
tegies, both speculative and defensive, as well as
discussing the main features of the product range
and comparing them to existing UK investment
products.
Warrants
Warrants are securities that are listed on stock
exchanges. They can be thought of as a form of
derivative that give investors the opportunity to
gain leverage in other words earn potentially
higher returns than they could do through direct
share ownership.
This leverage effect also increases the risk of the
product, but in contrast to some vehicles (such as
Futures, CFDs and spread-betting) investors
cannot lose more than their original investment.
A warrant gives an investor the right but not the
obligation to buy (known as a call warrant) or
sell (known as a put warrant) a specified under-
lying asset at a particular price (known as the
strike price) within a specified timeframe (known
as the maturity). For example, a Vodafone 1.50
Dec-04 Call Warrant would give an investor the
right to buy Vodafone shares at 1.50 during the
period up to and including December 2004.
The vast majority of warrants are cash settled,
meaning that investors receive the cash profit on
their position if they exercise their warrants rather
than the underlying asset. LSE listed warrants will
settle electronically within Crest. The UK Inland
Revenue has confirmed that investors in such
warrants do not have to pay UK stamp duty or
stamp duty reserve tax (currently 0.5% on UK
share purchases) on warrant trades.
In the UK, there are warrants available on a wide
range of UK and International blue-chip and mid-cap shares and indices (such as BP, Nokia, FTSE
100 and Nasdaq 100). All of these warrants are
traded in sterling.
The popularity of these products in other markets
particularly Germany, Italy and Switzerland
stems from the fact that they can be used to reflect
either a positive or negative view on a share or
index, or alternatively to hedge (reduce the risk
of) a larger portfolio of investments. This makes
them especially attractive in times of high market
uncertainty.
Certificates
A warrant which has no leverage is often referred
to as a Certificate. The price of this type of warrant
tracks the performance of the underlying asset
directly and as such offers a much lower risk
investment. They give investors a cost efficient
means to trade a share or to diversify their expo-
sure across an index or sector.
A FTSE 100 certificate for example would enable
an investor to buy a security whose return over
time will track that of the FTSE 100 index. This is
often a more cost efficient method than buying all
the constituent shares of the index or buying into a
pooled investment such as a tracker fund.
03
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02.WHY CONSIDERWARRANTS &CERTIFICATES?Global product range
Sterling denominated, locally traded
No stamp duty
Enables multiple investment strategiesRegulated, liquid and transparent market
Limited liability
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Global product range
Warrants and certificates give investors the ability
to trade the global financial markets we have
products based on UK, European, US and Japanese
stocks, sectors and indices.
Sterling denominated,
locally traded
Goldman Sachs products listed on the London
Stock Exchange are traded in sterling. Just as for
share trading, warrants will trade electronically and
will be available through on-line and traditionalstockbrokers across the UK. The transaction is
paperless with no exchange of physical certificates.
No stamp duty
The vast majority of warrants are cash settled,
meaning that investors receive the cash profit on
their position if they exercise their warrants rather
than the underlying asset. LSE listed warrants
will settle electronically within Crest. The Inland
Revenue has confirmed that investors in such
warrants do not have to pay stamp duty or stamp
duty reserve tax (currently 0.5% on UK share
purchases) on warrant trades.
Enables multiple investment
strategiesWarrants and certificates give investors the oppor-
tunity to execute a number of different investment
strategies not easily achieved with traditional share
investing. Some of these involve increasing or
reducing the risk of a given position. Others focus
on cost-efficiency or tax reduction. The most
common strategies are Leveraged Investment,
Hedging, Diversification, Cash Extraction and
Asset Allocation. These are explored in more
depth in Section three.
Regulated, liquid
and transparent market
Our activities are regulated by the Financial
Services Authority and our products are listed on
the London Stock Exchange. Goldman Sachs guar-
antees liquidity in its products, meaning, in normal
market conditions, we will always be present
during the trading day with competitive spreads to
buy or sell your security. Goldman Sachs warrants
are available in units in the 1 range, making
access to markets easier than with many other
investment products.
Limited liability
With warrants and certificates you can never lose
more than your initial investment, known as the
premium.
WHY CONSIDER WARRANTS & CERTIFICATES?
05
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HOW CANWARRANTS &CERTIFICATES BE USED?Using warrants for leveraged investing
Hedging a position or portfolio
Extracting cash
Diversification using certificatesAsset allocation
Trading warrants
03.
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HOW CAN WARRANTS & CERTIFICATES BE USED?
Warrants and certificates can be used to execute a
wide range of investment strategies. However,
before discussing any of these in detail it is impor-
tant to highlight the common questions that
investors should ask themselves before entering
into a trade:
What am I trying to achieve? If for
example investors are looking for leverage, they
should have a strong view on the future perform-
ance of the share or index in question.
What is my risk appetite? A wide
range of leveraged investment opportunities are
available to warrant and certificate investors (for
an explanation of leverage, please see page 8).
Warrants generally offer investors higher poten-
tial returns at a higher risk, while certificates
offer a much lower risk profile. Investors should
review their objectives and select a product based
both on their expected returns and their appetite
for risk.
What is the time horizon of my
strategy? There are two variables to bear in
mind: (i) the longer the maturity of a warrant the
more expensive it becomes and (ii) the closer the
warrant gets to expiry the greater its daily loss in
value.
Which is the cheapest warrant to
execute my strategy? If there is a
range of warrants available whose characteristics
match an investors needs, the selection process is
likely to be driven by price. Investors can selectthe cheapest warrant by trading the product with
the tightest spread (the difference between the
buy and sell price) and the lowest implied
volatility.
A number of the most common warrant and certi-
ficate strategies are detailed in the following pages.
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Using warrants for leveraged
investing
If you feel that a specific companys shares will rise,
you can make a small investment in call warrants,
as an alternative to direct investment in the equities
themselves.
On the other hand, if you think a particular index
is likely to fall, you could buy put warrants on that
index, allowing you to benefit if your analysis is
right and the index declines.
In both cases, the key distinguishing factor with
warrants is that they give you leverage. They allow
you to gain considerable exposure to an underlying
equity with a much smaller investment the
premium than would otherwise be required.
As such, the return from a warrant investment is
higher in percentage terms than that of the under-
lying asset if the investors view was correct. Con-
versely, if the investor was wrong then the warrant
will underperform the underlying asset. Warrants
effectively offer investors the chance of higher
returns at a higher risk.
A range of leverage is available different warrantshave different degrees of leverage, depending on
their characteristics. Among the factors that can
influence a warrants degree of leverage are the
time to maturity, the volatility of the underlying
stock, and the strike price. For a complete explana-
tion of the role these factors play, please refer to
section four.
On the 1st November 2001 investor A believes that Vodafone shares will rise over
the next few weeks from their current price of 1.59 to the 1.80 2.00 range
He could invest directly in Vodafone stock- with the following result
Alternatively, the investor could invest in a Vodafone warrant which would offerpotentially higher relative returns at a commensurately higher risk
STRATEGIES LEVERAGED INVESTMENT
BUY Vodafone Stock
@ 1.59
1st November 2001
SELL Vodafone Stock
@ 1.89
19th November 2001
BUY Vodafone 1.75
Call Warrant @ 0.203
SELL Vodafone 1.75
Call Warrant @ 0.392
+19%
or
+93%
GS Vodafone warrant in this example has a 1 yr maturity, a 1.75 strike and a 1 for 1 ratio
Note these calculations exclude transaction costs.
Prices are based on actual historical data.
Call
Put
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09
Hedging a position or portfolio
with warrants
If you expect share prices to fall, but do not want
to sell existing shares, you can buy put warrants to
hedge your portfolio against price declines. At the
same time, you can continue to participate on the
upside if share prices do rise.
Assuming that the mix of shares in your portfolio
reflects the composition of the FTSE index, you can
hedge against a possible share price decline by the
one-off acquisition of put warrants on the FTSE.
A hedging position can be thought of as a form of
market insurance where investors pay a premiumto protect themselves from market falls.
Asset allocation with warrants
and certificates
The Goldman Sachs warrant and certificate range
gives investors the ability to trade the global finan-
cial markets. As a result, investors are able to
apportion their exposure among a broad range of
equity markets and sectors.
On the 17th May 2002 investor B holds a portfolio of US Tech stocks. He is
concerned that the market may fall over the next month and he wants to insure his
portfolio against such an event
He can use warrants to do this by buying a Nasdaq put warrant which will rise as the
market falls and will leave the return of his total portfolio flat
STRATEGIES HEDGING A POSITION OR PORTFOLIO
US Tech Portfolio
10,000
17th May 2002
US Tech Portfolio
8,802
17th June 2002
Total Portfolio
10,910
Total Portfolio
10,882
12%
+/ 0%
Nasdaq Put Warrant
910
Nasdaq Put Warrant
2,080+129%
GS Nasdaq 100 warrant in this example has a 6 month maturity and a 1,200 strike
Assumes portfolio returns the same as the Nasdaq 100 Prices are based on actual historical data.
+
+
+
Shares
Put
HedgedPosition
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Extracting cash with warrants
If you want to use the capital you have tied up in
an investment without relinquishing your original
position, warrants can help. In this case, you sell
the underlying asset and, using a fraction of that
sum, buy call warrants to replicate the original
position. In this way, you can still participate in
any future upside gains in the original underlying
equity.
Diversification with index
and sector certificates
Index and sector certificates offer investors a cheap
and easy method of investing in a range of lower
risk diversified products. Our FTSE 100 certificate
tracks the performance of the FTSE 100 directly
and offers investors exposure to the performance of
the 100 largest companies in the UK. It is available
to trade all day and has none of the management
or administration fees that are sometimes con-
nected to tracker funds.
We offer other index certificates for investors
wanting to gain diversified exposure to foreignmarkets as well as sector certificates. The latter
allow diversification across markets but within one
sector (such as telecoms, financial services, tech-
nology, etc).
On the 27th November 2001 Investor C has a large position in British Airways
stock she wants to stay invested in the company but needs to free up some
capital for a down payment on a property purchase
She can use warrants to do this
Firstly: she sells her 10,000 shares in BA realising 21,750 in cash
Secondly: she buys 10,000 BA Warrants giving her the same exposure
to BA but at a lower cost (and also a higher risk) of 5,500
This strategy enables her to stay invested in BA and realise 16,250 in cash
STRATEGIES CASH EXTRACTION
Cost of warrants
to replicate exposure
5,500
Original Position in
British Airways
21,750
Cash Extracted
16,250
GS British Airways warrant in this example has a 9 month maturity, a 2.25 strike and a 1 for 1 ratio
Prices are based on actual historical data.
+
Cash
2. Buy 10,000 BAwarrants @ 55p
1. Sell 10,000BA @ 217.5p
Shares
Call
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Trading warrants
Once investors have purchased a warrant, they
have three potential courses of action:
Exercise if a warrant is in-the-money
investors may choose to exercise their rights to
buy (or sell in the case of a put) the underlying
asset and hence realise the intrinsic value of the
warrant. Because our warrants are cash-settled
investors would not receive the actual share but
rather the cash profit on their warrant (i.e. the
value of the underlying less the strike price in the
case of a call). In reality, investors very rarely
exercise warrants early because they are forfeitingany time value that the warrant may have.
They normally choose to close out instead.
All Goldman Sachs warrants are automatically
exercised on their expiry date if they are
in-the-money.
Close out investors close out positions by
selling their warrant back to the market. This is
done in order for an investor to realise both the
time value AND the intrinsic value of their war-
rant (please see section four for explanations of
time value and intrinsic value). The difference
between the purchase price and the sale price is
the profit investors have realised from their
warrant investment.
Abandonment If a warrant is worthless at
expiry an investor can abandon their position
and it will be automatically closed.
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04.HOW AREWARRANTS PRICED?
Intrinsic value
Time value
Factors determining a warrant price
Underlying asset priceStrike price
Time to expiry
Implied volatility
Risk-free rate of interest
Dividend expectations
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HOW ARE WARRANTS PRICED?
13
The price of a warrant is made up of two elements:
the warrants intrinsic value and its time value.
Intrinsic value
The intrinsic value of a warrant denotes the
amount that you could receive as a warrant-holder
if you were to exercise your right immediately.
Where the intrinsic value is zero, the entire price of
the warrant consists of time value.
For a call warrant, the intrinsic value is equal to
the amount by which the price of the underlyingasset exceeds the strike price. This should take into
consideration the warrants multiplier (the number
of warrants needed for the same exposure as
owning one share) and any currency factors. If this
value is less than or equal to zero the warrant has
no intrinsic value.
For a put warrant, the intrinsic value is equal to
the amount by which the price of the underlying
asset is below the strike price. Here, too, you take
the warrants multiplier and any currency factors
into consideration.
The example below illustrates how the relationship
between a warrants strike price and the value of
the underlying asset affects its intrinsic value.Above the strike price the intrinsic value will
increase by one point for a one-point rise in the
underlying asset.
Intrinsic value terminology
When the current price of the asset underlying the
call is higher than the strike price (or lower in the
case of a put warrant) your warrant has an
intrinsic value and is termed in-the-money. When
the current price of the underlying asset equals thestrike price, your warrant has no intrinsic value
and is termed at-the-money.
When the current price of the asset underlying a call
is lower than the strike price (or higher in the case
of a put warrant), the intrinsic value of your warrant
is also zero, this is known as out-of-the-money.
Warrants are typically more leveraged when they
are out-of-the-money than when they are in-the-money hence a one percent rise or fall in the
underlying asset will result in a more extreme move
in an out-of-the-money warrant than for an in-the-
money warrant.
EXAMPLE INTRINSIC VALUE
THE PRICE COMPONENTS OF A CALL WARRANT INTRINSIC VALUE
20
40
60
80
100
1,100 Price of theunderlying in Pence
1,0801,000
Intrinsic value in Pence
Strike price
at-the-money in-the-money
Intrinsic value = 80 Pence
out-of-the-money
900
A call warrant has a strike price of 1,000 Pence.
The conversion ratio is 1:1 and the price of the
underlying is 1,080 Pence.
Intrinsic value: 80 Pence
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Time value
The second component of a warrants price is its
time value.
In simplistic terms, time value can be thought of asa measure of uncertainty i.e. will the warrant
have any chance of having intrinsic value in the
future? All else being equal, the greater this level of
uncertainty the greater the time value of the
warrant.
Time value is at a maximum when a warrant is
at-the-money. As the warrant becomes out-of-the-
money, time value declines as it becomes increas-
ingly unlikely that the warrant will have any
intrinsic value in the future.
Similarly, as the warrant becomes in-the-money so
too its time value diminishes as it becomes increas-
ingly likely that the warrant will have intrinsic
value in the future (note although time valuediminishes in this example, the total value of the
warrant will increase due to the intrinsic value
component).
There are a number of factors that affect both the
intrinsic value and the time value of a warrant.
Together they are input into mathematical models
to calculate the price of a warrant. The next
section explores each of these factors in turn.
EXAMPLE TIME VALUE
THE PRICE COMPONENTS OF A CALL WARRANT
INTRINSIC VALUE AND TIME VALUE
20
40
60
80
100
1,100 Price of theunderlying in Pence
1,0801,000
Warrant price in Pence
Strike price
at-the-money in-the-money
Intrinsic value = 80 Pence
Time value = 20 Pence
Time value = 30 Pence
Maximumtime value = 60 Pence
out-of-the-money
900
A call warrant has a strike price of 1,000 Pence.
The conversion ratio is 1:1 and the
price of the underlying is 1,080 Pence.
Intrinsic value: 80 Pence
Time value: 20 Pence
Price of the warrant: 100 Pence
IN-THE-MONEY, AT-THE-MONEY, OUT-OF-THE-MONEY
Call Put
Price of the underlying > than the strike price in-the-money out-of-the-money
Price of the underlying = the strike price at-the-money at-the-money
Price of the underlying < than the strike price out-of-the-money in-the-money
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Factors determining a warrant price
The figure below shows the six components that
influence a warrants price this ignores the multi-
plier of the warrant and any currency factors.
Each of these components influences the price
of the warrant. They can neutralise, increase or
reduce the effect of other components. The matrix
below shows the effects of the individual determi-
nants on the price of a call and a put warrant.
Note The Sensitivity measures (or Greeks) are
used by market professionals to quantify the sensi-
tivity of a move of an individual input on a
warrants price
Underlying asset price
The performance of your warrant depends to a
large extent on the performance of the underlying
asset. A rise in the price of the asset on which your
warrant is based generally causes a rise in the price
of a call warrant. If you have a put warrant, the
opposite is true and the price of your warrant
generally falls.
Strike price
A warrants price also depends on its strike price,
which is determined at issue. The higher the strike
price relative to the underlying price, the cheaper
the call warrant or the more expensive the putwarrant will be.
WARRANT PRICING MODEL
Price of the
underlyingStrike price
Time to
expiryInterest rate
Dividend
expectations
Implied
volatility
Warrant pricing model
Warrant price
WARRANT PRICE
Delta
Theta
Vega
Rho
falls
falls
falls
falls
falls
falls
falls
falls
falls
falls
falls
falls Price of
the underlying falls
Strike pricefalls
Time to expiryfalls
Implied
volatility falls
Risk-free rate
of interest falls
Dividend
expectations falls
Determinant measure Influence on the warrant price Sensitivity measure
Call warrant Put warrant
rises rises
rises
rises
rises
rises
rises
rises
rises
rises
rises
rises rises
rises
rises
rises
rises
rises
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Time to expiry
This has a direct bearing on a warrants time value.
The more time remaining to expiry, the higher the
time value and so the higher the price of a war-
rant. This is because the longer the time period to
expiry, the wider the range of possible outcomes of
the future price of the underlying asset.
As the date of a warrants expiry draws closer, so
the time value declines. However, this does not
happen in a linear fashion. Rather, the decline will
accelerate as the warrant nears expiry. Without
going into the mathematical complexities, one can
think of this acceleration occurring because theimpact of a decline in the life of a warrant is much
greater in relative terms closer to expiry. For ex-
ample, a one-day decline in the life of a warrant
with 5 days to expiry reduces its maturity by 20%;
conversely a one-day decline in the life of a war-
rant with 100 days to expiry reduces its maturity
by just 1%.
Warrants that can be exercised at any point until
the expiration date are known as American style.
European style warrants can only be exercised on
the expiry date. For maximum flexibility, Goldman
Sachs warrants are typically American style.
All warrants whether American or European style
can be bought or sold on the stock market at any
time up to their expiry. To close out their positions
investors should sell back their warrants in the
market rather than exercising them in order to
realise both the intrinsic value and the time value
of the warrant.
Implied volatility
The volatility of the underlying asset is an essential
determinant of the time value of a warrant. Vola-
tility is a measure of the intensity of price move-
ments, not their direction. If the underlying asset
of a warrant has a high volatility then there isincreased uncertainty as to its future price. Again,
this uncertainty leads to a higher range of potential
outcomes, which in turn is reflected in a higher
time value.
Unlike the other components of a warrant price,
volatility is purely a best estimate and can vary
across the market. This estimate is often referred
to as implied volatility as it reflects the market
makers best estimate for future expected volatility.
One way of benchmarking a range of similar war-
rants is to compare their implied volatilities those
with the lowest implied volatilities generally offer
better value for money.
THE TIME VALUE OF A WARRANT RELATIVE TO THE TIME TO EXPIRY
200 150 100 50 5
Time value in Pence
Time to expiry in days
Warrant at-the-money
0,0
0,8
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Warrants with a higher implied volatility typically
have a higher time value than those with a lower
implied volatility. This is regardless of whether the
warrant is a call or put.
Risk-free rate of interest
Movements in interest rates will affect the time
value of a warrant. As interest rates rise, the time
value of equity call warrants will increase and vice
versa.
In order to understand this, consider a call warrant
as a deferred or delayed purchase of the underlying
asset. If this is the case, then, when interest ratesrise, investors will be happy to defer the purchase
of the underlying asset and instead put their capital
in a savings account to earn a high rate of interest.
As a consequence, call warrants become more
attractive to investors who wish to expose them-
selves to rising asset prices without actually having
to buy the shares themselves. This increased attrac-
tiveness is reflected in a rise in the time value of the
warrant.
The reverse is true with put warrants, which can be
viewed as a deferred or delayed sale of the under-
lying asset. If interest rates are rising, investors are
less likely to want to delay the sale of their shares,
as this prevents them from being able to put the
capital in the bank and earn a high rate of interest.
As a result, the time value of put warrants typically
falls as interest rates rise.
Dividend expectations
Changes to dividend expectations also affect the
time value of a warrant. If dividend expectations
increase, the time value of equity call warrants will
fall whilst the time value of put warrants will rise.
Once again, if call warrants are viewed as a
deferred purchase, an increase in dividends will
make delaying a purchase less attractive, and
consequently prices will fall. In the case of a put
warrant the reverse is true, as a deferred sale
becomes more attractive to investors and will drive
prices up.
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05.HOW DO WARRANTS &CERTIFICATES DIFFERFROM OTHER UKINVESTMENT PRODUCTS?
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The UK investment market offers investors a very
diverse range of products. This diversity comes in
a number of forms how risky the product is, the
asset class to which the investor is gaining expo-
sure, the taxation of the investment, its liquidity
and so forth. How do warrants and certificates fit
into this landscape?
If we compare them to other equity products on
a risk basis then certificates would be similar to
pooled investments such as unit or investment
trusts. Warrants on the other hand are inherently
riskier and would fit between traditional share
trading and higher risk derivative products such
as futures and options.
For a number of years, company and investment
trust warrants have been available in the UK.
Unlike Goldman Sachs warrants, these products
confer the right to buy new shares in the company
or investment trust conducting the issue. Due to the
limited issuance of these products there have been
problems in the past with liquidity and consistency
of pricing.
HOW DO WARRANTS AND CERTIFICATES DIFFER
FROM OTHER UK INVESTMENT PRODUCTS?
HAVENT WARRANTS BEEN AROUND
IN THE UK FOR SOME TIME?
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UK Equity-linked
Product Group
Listing &
Availability
Taxation Policy Typical Associated
Trading Charges
CollectiveInvestmentSchemes InvestmentTrusts, UnitTrusts andICVCs
Certificates
Exchange TradedFunds (ETFs)
UK Shares
Warrants
Company andInvestment Trustissued Warrants
UK Options &Futures
Contracts forDifference(CFDs)
Spread-bets
Investment trusts are
LSE listed and avail-
able to trade via
brokers. Unit trusts
and ICVCs are avail-
able in the primary
market only
LSE listed Available
through the majority of
UK brokers
LSE listed Available
through the majority of
UK brokers
LSE listed Available
through the majority of
UK brokers
LSE listed Available
through the majority of
UK brokers
LSE listed Available
through the majority of
UK brokers
LIFFE listed Available
through designated
brokers margin
account required
Not exchange listed
available through
specialist brokers
margin account
required
Not exchange listed
available through
spread-betting compa-
nies only
Stamp Tax payable
(although relief regime
in place for Unit Trusts
and OEICs). Income
and Capital Gains Tax
payable by the
investor over personal
allowances (these can
be reduced through
the use of an ISA)
No Stamp Tax. Capital
Gains Tax on gains
over 7,500 CGT
allowance
No Stamp Tax. Income
tax on dividends and
CGT on gains over
7,500 allowance
Stamp, Income and
Capital Gains Tax
payable (the latter two
can be reduced
through the use of an
ISA)
No Stamp Tax. Capital
Gains Tax on gains
over 7,500 CGT
allowance
Stamp and Capital
Gains Tax on gains
over 7,500
CGT allowance
Capital Gains Tax on
gains over 7,500 CGT
allowance
No Stamp Tax. Capital
Gains Tax on gains
over 7,500 CGT
allowance
No taxes apply
Broker commission,
management fees,
redemption charges
and bid/offer spread
(not in the case of
ICVCs)
Broker commission
and bid/offer spread
Management fee,
broker commission
and bid/offer spread
Broker commission
and bid/offer spread
Broker commission
and bid/offer spread
Broker commission
and bid/offer spread
Broker commission
and bid/offer spread
Broker execution fee,
funding spread and
bid/offer spread
Bid/offer spread and
rolling costs (closing
and re-opening bets
for longer-term expo-
sure)
Low Typically diversi-
fied investment
some are passive and
try to replicate the
returns of a pre-
defined benchmark,
others are active
which try and outper-
form a pre-defined
benchmark (this cate-
gory can be a higher
risk investment)
Low Typically diversi-
fied products that
passively replicate the
returns of a certain
index or sector. Single
stock certificates offer
no diversification
Low Typically diversi-
fied products that
passively replicate the
returns of a certain
index or sector. Activ-
ely managed ETFs are
as yet unavailable
Low/Medium Can
lose initial investment
but no more, no diver-
sification
Medium Can lose
initial investment but
no more, diversifica-
tion with index and
sector warrants
Medium Leveraged
product. Can lose
initial investment but
no more
Medium/High Lever-
aged product. Can
lose initial investment
but no more when
buying options. Can
lose more than initial
investment when
selling options and
trading futures
High Leveraged
product. It is possible
to lose more than
initial investment (stop
loss accounts can be
arranged at higher
cost)
High Leveraged pro-
duct. It is possible to
lose more than initial
investment (stop loss
accounts can be ar-
ranged at higher cost)
No leverage (except for
futures and options funds)
Typically diversified across
a pre-defined asset class
country or sector specific,
large and small-cap com-
panies etc
Pricing of unit trusts and
ICVCs driven by NAV
calculation, pricing of
investment trusts driven
by supply and demand
No leverage
Bi-directional investors
can be long or short the
underlying index, sector or
stock
Diversified in the case of
index and sector products
No leverage diversified
across a pre-defined asset
class
Equivalent to being long
the underlying
Pricing driven by NAV
No leverage
Typically a long only
investment although
shorting is available
through some brokers
Income (in the form of
dividends) and capital
gain to holder
Leveraged product
through optionality
Similar economics to
options but investors
can only buy warrants,
they cannot sell them
Global underlying range
Maturities to five years
Leveraged through option-
ality
Issued by companies or
investment trusts on their
own stock typically call
warrants only
Dilutive, typically long-
dated, pricing on supply/
demand basis
Leveraged through option-
ality (for options) and
margining (for futures)
UK underlying range-index
and FTSE 100 stocks, plus
some foreign underlyings
with USFs
Option maturities to nine
months and bi-directional
Leveraged through
margining
Global underlying range
and bi-directional
Interest charges on long
positions, interest pay-
ments on short positions
Leveraged through
margining
Global underlying range
and bi-directional
Typically short maturity
3 months
Product FundamentalsTypical Riskiness of
product group
Trusts or investment compa-
nies that enable investors to
pool their resources into a
collective scheme which
then invests in a wide range
of securities in order to
reduce risks through diver-
sification
Securities issued by a third
party that track the perform-
ance of a specified index,
sector or share
Securities that are similar to
collective investment
schemes but offer greater
price transparency and typi-
cally lower charges
Securities that represent part
ownership of a company.
Typically confer the right to
vote in General meetings and
receive dividends
Securities issued by a third
party that offer investors the
right but not the obligation to
buy or sell an underlying
asset at a set price within a
specified timeframe
Securities issued by a
company that confer the
right to buy new shares in
that company at a fixed price
on a future date
Options are contracts that
give the holder the right to
buy or sell an underlying
asset at a fixed price within a
specified timeframe. Futures
are contracts that require one
party to buy a specified asset
from another party at an
agreed price on a set date in
the future
Contracts where the investor
can buy or sell exposure to
an asset on margin (i.e.
paying only a percentage
of the total value- typically
10-20%)
A bet where participants buy
or sell exposure to an asset
on a per tick basis (e.g. 10
per index point on the FTSE
100)
Description
UK WARRANTS AND CERTIFICATES: A PRODUCT COMPARISON
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06.WHY GOLDMAN SACHS?Goldman Sachs at a glance
21
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22
WHY GOLDMAN SACHS?
Goldman Sachs, one of the worlds most highly-
respected investment banking and securities firms,
is offering a new opportunity for UK personal
investors: Warrants and Certificates.
This follows over a decade of success in building
markets in Europe, where today Goldman Sachs
offers clients a product range of more than 5,000
warrants and certificates. Further afield, Goldman
Sachs is a warrant market leader in Japan.
Now, as a UK investor, you can use Goldman Sachs
warrants to maximise returns or minimise risk inyour investments.
The Goldman Sachs range of warrants and certifi-
cates in the UK is based on an exciting selection of
domestic and international shares and indices, with
multiple combinations of maturity and leverage
available. We try to create a suite of products to
suit every market condition and investor viewpoint.
Goldman Sachs warrants and certificates trade just
like shares do, on the London Stock Exchange.
Goldman Sachs provides a highly liquid and
transparent market.
You can trade them by name through participating
UK brokers. Investors cannot deal directly with
Goldman Sachs.
The Goldman Sachs warrant website offers
valuation and selection tools to help you find the
product best suited to your investment objectives.
It also features real-time pricing information thatcan be personalised to track your warrant port-
folios.
Visit www.gs-warrants.co.uk
to learn more.
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23
www.gs-warrants.co.ukWARRANTS INVESTOR HOTLINE: 0845 609 1555
GOLDMAN SACHS AT A GLANCE
One of the worlds oldest and largest investment
banking firms. Originally a partnership founded
in 1869, Goldman Sachs has been a public
company since 1999.
Offering a full range of investing, advisory and
financing services to a global client base of major
corporations, leading financial institutions,
governments and high net-worth individuals.
Headquartered in New York, with European
operations centred in London. In total, GoldmanSachs has over 40 offices in more than 20 coun-
tries, allowing it to combine profound know-
ledge of local markets with unrivalled interna-
tional execution abilities.
Goldman Sachs is constantly developing and diver-
sifying; applying expertise and creativity to help
clients identify and capitalise on opportunities
anywhere in the world.
Goldman Sachs customers join the ranks of
managers of major mutual funds, pension funds
and the investment departments of the leading
insurance companies who have come to trust our
market expertise. We are committed to meeting
their objectives and yours. We do this by calling
into play our acknowledged strengths in globalinstitutional trading and our comprehensive equity
research coverage. This allows us to react quickly
to or even anticipate the world events, industry
trends and company performances that drive global
markets.
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24
07.WARRANTSAND CERTIFICATESGLOSSARY
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25
WARRANTS AND CERTIFICATES GLOSSARY
American style warrant
A warrant that can be exercised at any time during
its life.
Ask
The price at which a warrant market-maker is
willing to sell a warrant.
At-the-money
When the spot price of the underlying is equal to
the strike price of the warrant.
Automatic exercise
When the owner of the warrant automatically
receives the intrinsic value (if any) at expiry
without having to take any direct action himself.
The form of exercise is determined by the issuer at
the time that the warrant is issued, as part of the
terms of the warrant.
Basket
An underlying comprised of a series, or basket, of
different securities, indices or other financial assets.
Bid price
The price at which a warrant market-maker is
willing to buy a warrant.
Binomial model
A numerical model for calculation option prices
which works for both American and European
style options. The binomial model is more general
than the Black-Scholes model and is typically the
model used for option price calculations.
Black-Scholes model
A model used to calculate the value of a European
style call option. Developed in 1973 by Fischer
Black and Myron Scholes. It uses the stock price,
strike price, expiration date, expected dividends,
risk-free rate of return and the annualised standard
deviation (volatility) of the stocks return. For
American style options a different type of model
(normally a binomial model) is used.
Break-even
The underlying asset price at which the buyer of a
warrant makes neither a profit nor a loss if the
warrant is held to expiry. The break-even price for
a call is equal to the strike price plus the price paid
for the warrant, taking into account any multipliers
and cross-currency effects. For a put it is equal to
the strike price less the warrant price paid.
Call warrant
Confers the right but not the obligation to buy a
quantity of an underlying asset at a predeterminedprice on or before a predetermined date (or the
cash equivalent of this right).
Cash settlement
A form of settlement whereby the underlying asset
is not delivered to the holder of the warrant at
expiry, but rather the holder receives the intrinsic
value (if any) of the warrant in cash. Cash settle-
ment is typically more convenient for warrant
holders and has favourable stamp duty implications
in the UK.
Certificate
A form of warrant where the strike price is very
low (for calls) or very high (for puts) so that the
performance of the certificate closely matches the
performance of the underlying (or the inverse for a
put).
Closing price
An officially determined price for a security on a
particular trading day on a particular exchange
usually the last traded price or closing auction
price. The closing price of an underlying is typically
used as the reference for calculating amounts for
cash settlement.
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26
Company-issued and investment
trust warrants
Warrants issued by Companies or Investment
Trusts to raise capital. Upon exercise, the company
or trust will issue new shares or units, and hence
this type of warrant is part of the capital structure
of the issuer and is dilutive. This type of warrant
differs in many fundamental ways from covered
warrants and is not equivalent to a covered
warrant.
Contingent liability contract
A contract where one or both parties may have
payment obligations in future in addition to thoseat the inception of the contract. For example,
futures and spread bets may require the purchaser
to make payments in excess of their original invest-
ment if markets move adversely. In contrast,
warrants have no contingent liability for the
purchaser and the amount paid for the warrant is
the maximum possible loss.
Conversion ratio
The number of Warrants that must be exercised to
either buy (call) or sell (put) a unit of the under-
lying asset. (See also multiplier.)
Corporate action
An event in the underlying asset which requires
a change to the terms of a warrant in order to
preserve the economic positions of both the
warrant holder and the warrant issuer. An example
of a corporate action is a stock split or a spin-off.
Covered warrant
Covered Warrants are a specific sub-type of option
where the option contract is in the form of a trad-
able security. The security is issued by a third party,
such as an investment bank, rather than by the
issuer of the underlying asset. The cover refers to
the fact that the issuer buys or sells (covers) its
position in the market for the underlying asset.
Covered warrants are different from company
issued or investment trust warrants in many funda-
mental ways.
Delta
Delta is the amount by which the value of awarrant changes when the price of the underlying
changes by one unit, all other factors remaining
constant. For calls, the delta lies between 0 and 1;
for puts it lies between 0 and 1.
Derivative
Securities or contracts whose value is derived from
that of another asset or assets for example,
futures, options and warrants.
Dividend yieldThe dividend expressed as a percentage of the stock
price.
Diversification
The allocation of investments in a portfolio across
different securities, sectors or regions in an effort
to mitigate risk.
European style warrant
A warrant that can be exercised only on the
expiry date.
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27
Ex-dividend date
The date on which a stock starts trading without
entitlement to the last dividend. As a result, the
market price of the underlying normally adjusts
(e.g. drops) by the dividend amount.
Exercise
To invoke the right embodied in a warrant
asserting the right to buy the underlying asset at
the strike price (for calls) or sell the underlying
asset at the strike price (for puts); or to receive the
cash equivalent of this assertion. Note that,
because exercise delivers the intrinsic value of a
warrant and the value of a warrant is made up ofboth time value and intrinsic value, exercising early
generally delivers less proceeds to the holder than
selling the warrant.
Exercise period
The period over which the rights of the warrant
can be exercised, after which these rights lapse.
Exercise price see strike price
Exotic warrantA warrant with a non-standard structure (unusual
procedures for calculating or determining the strike
price or expiry value, the combining of caps and
floors, or the use of a barriers, for example).
Expiration date
The date on which a warrant expires and after
which the rights embedded in the warrant lapse.
Fair value
The theoretical value of a warrant as determined
using option pricing models.
Gamma
The metric used to describe the rate of change of
a warrants behaviour relative to the underlying
(delta). Gamma is defined as the rate of change
of delta.
Gearing
Gearing = Underlying Price/(warrant price X multi-
plier). Aimed at describing the level of equity expo-
sure achievable, with a particular warrant, gearing
is not generally considered to be as valuable a
metric as Leverage, which factors in the warrants
delta. (Please see Leverage)
Hedge
To buy or sell an asset to offset the risk generated
by a transaction in a related asset. For example, if
an investor wanted to reduce the risk of holding a
share portfolio whose performance closely matches
that of the FTSE 100 Index, the investor couldpurchase a FTSE 100 Put Warrant.
Historical volatility
A measure of the intensity of price fluctuation of
an underlying over a certain period in the past,
measured in terms of annualised standard deviation
of historical returns. (See volatility)
Implied volatility
Implied volatility is an estimate of an underlyings
volatility for a particular period in the future.
Implied volatility can be calculated (implied) by
taking the current warrant price and all other
known parameters of the warrant, and working
backwards through an option pricing model.
In-the-money
When the spot price of an underlying is above the
strike price (for calls) or below the strike price (for
puts). In other words, the warrant currently has
some intrinsic value.
Intrinsic value
For calls, the amount by which the underlying price
exceeds the strike price adjusted by the multiplier
to a per warrant amount. If the underlying price is
less than the strike price, then the intrinsic value is
zero. For puts, the intrinsic value is the amount by
which the strike price exceeds the underlying price
adjusted by the multiplier to a per warrant amount.
If the underlying price exceeds the strike price, then
the intrinsic value is zero.
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Issuer
The party who must fulfill the obligations
embodied in the warrant. For covered warrants,
the issuer is typically a bank, broker or investment
bank.
Leverag/elasticity
Leverage is the percentage change in the price of a
warrant for a one percent change in the price of the
underlying (as opposed to delta, which measures
absolute changes).
Life see exercise period
Lot size
The minimum multiple in which a warrant can be
traded or exercised. For example, a lot size of 100
means that a warrant trades in a minimum size of
100 warrants and multiples of 100 warrants there-
after.
Market-maker
The entity (usually a broker) obliged to provide a
bid price and a sell price for the warrants in ques-
tion at all times.
Maturity see expiration date
Multiplier
The number of units of underlying controlled by a
single warrant. Multiplier is the reciprocal of the
conversion ratio.
Offer price see ask price
Off-exchange trade
A transaction concluded directly between two
parties without involving an exchange as an inter-
mediary.
Option
A contractual agreement between two parties
which grants the buyer the right (but not the obli-
gation) to receive (call) or deliver (put) a certain
underlying asset from (to) the seller at a pre-deter-
mined price on a certain date or dates in the future.
Out-of-the-money
When the spot price of an underlying is below the
strike price (for calls) or above the strike price (for
puts). In other words, the warrant currently has no
intrinsic value.
Physical delivery
Fulfillment of the rights and obligations of a
warrant by exchanging the underlying against
payment of the strike price (as opposed to cash
settlement).
Premium
For a given warrant price, the percentage by whichthe underlying price needs to rise (for calls) or fall
(for puts) in order for a warrant holder to break
even at expiry (i.e. for the intrinsic value at expiry
to equal the given warrant price). Confusingly, the
term warrant premium is also sometimes used to
refer to the warrant price itself.
Prospectus/listing particulars
A legal document or set of documents which set
out the rights of warrant holders and the obliga-
tions of the warrant issuer.
Put warrant
Confers the right but not the obligation to sell a
quantity of an underlying asset at a predetermined
price on or before a predetermined date (or the
cash equivalent of this right).
Real-time quote
A published price for a security which matches the
actual tradable price of the security.
Rho
The metric used to describe the effect of a change
in interest rates upon the price of a warrant.
Risk free interest rate
Used by Black Scholes as part of the equation to
work out a warrant fair value it is typically
derived from the appropriate interbank loan rate
for the relevant time frame. (Please see description
of Black-Scholes model.)
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Securitised derivative
A derivative, usually an option, in the form of a
security (a negotiable instrument). Both certificates
and covered warrants are forms of securitised
derivative.
Spot price
The current market price for the underlying.
Spread
The difference between the bid price and offer
price.
Strike priceThe predetermined price at which the underlying
can be bought (for calls) or sold (for puts) as
defined in the terms of the warrant.
Stamp duty
Stamp duty and stamp duty reserve tax are govern-
ment charges on the transfer of certain securities
between parties. In the UK stamp duty is levied on
share transactions at a rate of 0.5%, paid by the
buyer. The UK Inland Revenue has confirmed that
UK stamp duty and SDRT are not payable on cash
settled warrants which are traded electronically.
Term see exercise period
Theta
A measure of the change in value of a warrant as
the remaining life to expiration decreases. Theta is
used to mathematically represent the decay of a
warrants time value.
Time decay see theta
Time value
The amount by which the current warrant price
exceeds the intrinsic value of the warrant. Time
value is a measure of the possibility of a more
favourable outcome in future.
Underlying
The financial asset to which a warrant relates. This
could be an exchange rate, an equity index, a
share, a debt instrument, a commodity or a combi-
nation of such assets.
Vega
The metric used to describe the effect of a change
in implied volatility upon the price of a warrant.
VolatilityA statistical measure of the intensity of fluctuations
in price of an underlying, expressed as an annu-
alised value. Volatility can be historic (looking at
actual volatility of an asset over a particular time
period in the past) or implied (an estimate of
volatility for a particular period in the future).
DISCLAIMER
This information has been prepared by the Equities
Division of Goldman Sachs International (GSI, andtogether with its affiliates GS) and is not the
product of the research department. It is for your
general information only and does not solicit you to
take any action or enter any transaction based on the
information contained herein. This information does
not constitute an offer, invitation or proposal to
promote the warrants referred to herein to any
person nor does it constitute a proposal to enter into
any contractual relationship with GSI. Investing in
warrants entails risk and you may lose your full
investment. GSI is not recommending that warrants
are a suitable investment for any category of
investors or for investors in general. You should
ensure that your broker provides you with the rele-
vant Risk Warning. GSI does not provide regulatory,
legal, accounting or tax advice. You are thereforeencouraged to seek independent advice on these
matters. This material has been prepared based
upon information that Goldman Sachs International
believes to be reliable. However, Goldman Sachs
International does not represent that this material is
accurate, complete and up to date and accepts no
liability if it is not. Any historical price(s) or value(s)are also as of the date indicated. GSI may be the only
market maker in the warrants referred to herein. GS
may, by virtue of its status as an underwriter, advisor
or otherwise, possess or have access to non-publicly
available information relating to the companies and
assets that are mentioned herein and shall be under
no obligation to disclose such status or any public
or non-public information. GS may from time to
time be an active participant on both sides of the
market and have long or short positions in, or buy
and sell, securities, commodities, futures, options,
warrants or other derivatives (together invest-
ments) (on a principal basis or otherwise) identical
or related to those mentioned herein and hedging
activities by GS relating to the products referred to
herein may affect the price of such investments andaccordingly the price of such products. Further infor-
mation may be obtained upon request from GSI's
London office at 133 Fleet Street. GSI is regulated by
the Financial Services Authority.
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Goldman Sachs International
Peterborough Court133 Fleet Street
To learn more about Goldman Sachs warrantsand benefit from our warrant price alert service,
please visit our website:
www.gs-warrants.co.ukWarrants investor hotline: 0845 609 1555