Question

What is a right? How are rights created? Suppose you own 100 shares of ABC Company, which has just announced a rights offering. You will be able to purchase one share of common stock at $20 a share plus four rights. The current market price of the stock is $25 a share.

What will each right be worth after the rights are issued and begin trading? Is it to your advantage to: a) sell the rights, b) use the rights to buy more shares, or c) discard the rights? Explain your answer using a numeric example.

Answer 1

1. A Right issue is a voluntary corporate action announced by the company, it is a way by which a listed company can raise additional capital instead of going to the public. The rights are offered to the existing shareholders in proportion to their exiting holdings.

2. The basic idea of a rights issue is to raise funds, this can be either for expansion, takeover, etc. A Right is created taking into account the element of equity capital and market capitalisation. Rights are created and offered at a discounted value so that they are an attractive offer for the shareholders to subscribe to.It is generally made as a tax free dividend on a ratio basis. For example: 3 rights for every 2 common share held.

3. It would always be an advantage to opt for the rights considering the company is doing well and the market value is greater than the Rights issue value, the shareholders must opt for using their rights to buy the shares. These shares can then anytime be sold in the secondary market once the prices rise.

Below is an example for your reference:

Comment	Total Share	Rights Price	Market Price
Shares held initially	100	20	25
Assuming for 1 share you hold you will get 4 right shares(100*4)	400
Value of the rights shares (Considering 400 shares at price 20)	8000
If shareholder purchases at market value (Considering 400 shares at price 25)	10000
Profit if opted for rights issue	2000