Question:
They tell me that I can earn extra income from dividends when buying warrants rather than shares, how does this work?
Answer:
Instalment warrants gives holders the ability to gain exposure to price movements in underlying shares by making an initial payment and an optional second payment on expiry. There are a number of benefits of using Instalment Warrants including leverage and diversification, prepaid interest deductibility and enhanced dividend yield.
To address this month’s question, we will discuss the enhanced dividend yield benefit.
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Holders of Instalment Warrants are entitled to the full dividend and franking credits paid on the underlying share, even though they may have only partially paid for the share (i.e. paid the first instalment).
Generally, an Instalment’s price is 50% of the underlying share price, so the dividend stream represents an enhanced yield compared to the income received by the holder of a fully paid share.
As you can see the dollar amount per dividend is the same for both a direct share investment and an Instalment. In percentage terms, however, the returns from the Instalments are much higher because of the smaller capital outlay. The more highly geared the Instalment the higher the dividend yield.
In addition to an enhanced dividend yield, holders may also earn additional income from holding Instalments over Australian shares, as they can also gain proportionally more franking credits than they would from holding the underlying share. The higher franking credits may be particularly attractive for superannuation funds where they can potentially be used to offset tax payable both on the fund’s earnings and on contributions into the fund.
