Hello and welcome. You are listening to Patrick Boyle on Finance, a podcast exploring ideas from quantitative finance, examining events occurring in markets right now and financial history to see what lessons can be taken away, including interviews with some of the most interesting people in the world of finance. To learn more about the podcast, visit onfinance.org.

Okay, we have a good topic today. We're back to the roots of this channel, which is financial derivatives and how they work.

If you haven't yet seen the news, J.P. Morgan is suing Tesla for $162 million,

claiming that Tesla failed to make a required payment that was triggered after Elon Musk's announcement

that he was taking the company private back in 2018. In the court filing, J.P. Morgan says that warrants sold by Tesla to J.P. Morgan had

required the bank to make adjustments after Musk said on Twitter that he had funding secured

to acquire the company at $420 a share.

When Tesla later announced that it was abandoning the transaction, the value of the warrants

once again changed and J.P. Morgan was again obliged to adjust its position.

The whole lawsuit relates to a convertible bond that was issued by Tesla back in 2014.

Convertible bonds, if you don't know, are a type of bond that the holder can convert into

shares of common stock into issuing company or the cash equivalent value at an agreed-upon

price.

They typically have a low coupon or at least lower than otherwise similar debt, but they

carry additional value through

the option to convert the bond into stock.

This embedded option is a warrant rather than a call option and the biggest difference

between a warrant and a call option is that warrants create dilution as when they're

exercised the company issues new equity to deliver to the warrant

holder.

A simple way of thinking of it is that when you make money through a call option, the money

that you made comes from the trader who sold you that option.

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