Assume company XYZ has announced rights issue in the ratio of 5:2 (for every 5 shares additional 2 shares are offered). If you hold 100 shares of XYZ then you will be entitled to get 40 (100 * 2/5) new shares of XYZ. The new shares are usually given at deep discount price so that the full issue gets subscribed and the company may raise the required capital. A future date is fixed for this corporate action.
After this corporate action the share price comes down proportionate to the issue ratio, theoretically. Actual value differs from this theoretical value based on the intention of the funds’ raise.
Consider share price of XYZ is Rs 300 and the company is offering new shares at Rs 200 and you hold 100 shares of XYZ.
You can buy 40 shares at Rs 200. The amount required to buy new shares Rs 8000.
Value of the existing shares 300 * 100 = Rs 30,000
Total value of 140 shares = 30,000 + 8000 = Rs 38,000
Theoretical share price ex-rights = 38,000 / 140 = Rs 271.5
In case of rights issue you have the below options to choose.
1. No action at all. It’s not recommended since it dilutes the value of your existing shares. i.e. in the above example you would left with 100 * 271.5 = Rs 27,150 (whereas the original value was Rs 30,000).
2. Opt to buy all the shares you are entitled to by paying Rs 8000. As explained above. You will have 140 shares with a theoretical price of 271.5
You can buy a part of the shares you are entitled to.
3. Opt to sell the shares to other investors or the underwriter in which case theatrically you would get Rs 271.5 * 40 and you need to pay Rs 8000 (40 * 200) . Capital gain is the difference which is Rs 2860. Of course there will be capital loss on your existing 100 shares to compensate this.
The actual ex-rights price depends on the intention of funds’ raise and market sentiment. So you may end up in losses or profit depending on the option you choose.ADVERTISEMENTS