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Instalment Warrants are a derivative used in financial markets to gain leverage without having to recognise the debt as it is in effect a non-recourse loan because it has a put option attached to it.

In plain speak if I can....

Warrant issuers such as Macquarie Bank buy 10,000 NAB shares. They then package it as an instalment warrant by selling the shares to investors with an installment owing on the shares - this is the amount you see published in the newspapers. For example I have some NABIMC warrants with $17.00 owing on the shares. In todays market you would pay $14.50 for the warrant giving you a total purchase price of $31.50 but some of this will be prepaid interest which is tax deductible.

The critical difference between warrants and margin loans is that the warrants have a put option attached to them so that if NAB should suddenly go broke I can sell the NAB shares back to MAcquarie Bank at $17 and effectively cancel out my loan. As you know with a margin loan they still want their money back.

The interest rates are very similar and the "cost" of the put option is built into the pricing. Because of the put option the loan has a non-recourse nature and therefore does not have to be taken up on the books which makes them very attractive to superannuation funds as they can gear their portfolios. Under most normal circumstances super funds cannot borrow money.

The other beauty of them is that they can be rolled over into new series without any capital gains tax implications as the underlying shares are not transferred, only the loan attached to them.

I don't trade in them but am aware of some people who do. The warrant issuers are supposed to keep a liquid market but you will always find a spread of a few percent in any Macquarie Bank series. The new warrants that Commonwealth Bank have been issuing have a much lower spread which will help traders.

Depending on your nature you can buy warrants with about 50% gearing and sometimes up to 80% gearing involved.

The risk that you must assess is when rolling over in to a new series if the price of the underlying share has dropped then the instalment loan will be lower and therefore you will b required to make a payment to pay down the existing loan to roll over into the new series.

They can also be used if you have an existing portfolio by having warrants issued aginst the shares and therefore no CGT will be payable but you will have to pay interest costs.

Endowment warrants are similar but instead of receiving the dividends from the companies they use this to pay down the loan. I have not ever used them and don't know as much about them or their cost structure, maybe someone else can help there.


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