The use of warrants lowers the coupon rate on the corresponding debt issue. Does this mean that the component cost of a debt-plus-warrants package is less than the cost of straight debt? Explain.

Explanation

To the issuing company, the cash flows of bonds with warrants is not limited to principal and interest payments.
The expected market price and exercise price of the stock should be considered as cash outflow and be used in the computation of the effective cost of debt.
Corporations are obliged to issue stocks at the exercise price of the warrants even if the market price of the stock has gone up rapidly.

Sample Response

Debt securities with warrants have lower nominal interest rates than pure debt securities of similar risk. However, the effective cost of debt will be higher considering its complexity and the uncertainty of cash flows from the warrants.