What Is Harmless Warrant?

The term harmless warrant refers to a provision that requires bondholders to surrender an existing bond if they want to purchase the same type of bond from the issuer. Put simply, bond issuers put harmless warrants on their bonds, requiring investors to swap their existing bond if they want to purchase another one with similar features from the same issuer. Harmless warrants are a safety net for bond issuers as they help keep their debt levels in check.

Understanding Harmless Warrants

Warrants are derivative securities that allow the holder the right—not the obligation—to purchase or sell a specific security at a specific price before the expiration date. They come in several different forms, including harmless warrants.

A harmless warrant is attached to bonds and offered by bondholders. An investor who buys a bond with a harmless warrant cannot purchase another bond from the same issuer with the same terms until the investor surrenders the first bond they purchased. This includes any bonds that have the same maturity date, yield, and principal amount. As such, Mr. Investor can't purchase a $1,000 10-year bond from Company A without surrendering the first one they own with the same terms.

Bonds are a form of debt for the issuer. The investor lends the entity a specific sum of money for a period of time in exchange for the principal balance plus interest at maturity. As such, these instruments add to the issuer's total amount of debt. Issuing bonds with harmless warrants allows these entities to control their debt levels. In this way, an investor can't get too much leverage on the issuer while preventing the issuer from getting into a dangerous situation in which an investor calls multiple bonds that the issuer can't cover.

One important point to note is that not all issuing entities attach harmless warrants on their bond offerings.

Special Considerations

If harmless warrants prevent investors from purchasing multiple bonds with similar terms from the same issuer, what happens if someone wants to buy different bonds from the issuer?

These warrants don't prevent bondholders from purchasing bonds with different terms from the same issuer. This means they may purchase other bonds with different maturity terms, yield rates, and principal amounts. Keep in mind, though, that most investors generally want to repeat certain investments because of the favorable terms they carry, so a harmless warrant forces an investor to decide which of the terms are the most crucial. That is unless they are willing to surrender the original bond to purchase a new one with the same terms.

Harmless Warrant vs. Warrant

Remember that a harmless warrant gives the holder the right to purchase another bond at the same terms as the bond to which the harmless warrant applies. However, the harmless warrant does not give the holder the right to own two bonds with the same terms at the same time. Instead, it requires the holder to surrender the first bond to be allowed to buy the second bond with the same terms.

A warrant, on the other hand, is a type of derivative security because it gives the holder the right to act in some way with another security. A warrant gives the holder the right to buy or sell another security at a specific time, although the warrant holder does not have the obligation to exercise this warrant. The holder of the original security purchases the warrant to have the right to do whatever the warrant delineates.