Rights issue or rights offering

RIGHTS ISSUE

Normally, whenever an existing company makes a fresh issue of equity capital or convertible debentures the existing shareholders or convertible debenture holders have the first right to subscribe to the issue in proportion to their existing holdings.  Only what is not subscribed to by the existing shareholders can be issued to the public.  Thus, an issue offered to the existing shareholders or convertible debenture holders as their right is known as rights issue, as opposed to an issue open to the public at large, in which case we call it a public issue.  An investor may exercise this right to subscribe to the offered issue, or he may sell the rights separately in the market.  The rights have a market value only when the issue is made below the market value of the security.  When this happens, as can be expected, the market price drops a little.  The price of the security before the rights issue is known as the cum-rights price. The difference between the cum-rights and ex-rights price is a measure of the market value of a right, through increase in shares prices.

IS THE PRICE AT WHICH THE RIGHTS ARE ISSUED IMPORTANT:

The price at which a rights issue is made is irrelevant.  In order to understand this, consider the example of a company, which has 100000 ordinary shares outstanding with a market price of Rs.40 per share.  This is the cum-rights price.  The total market value of the shares (also known as market capitalization) at this stage is Rs.4000000 (Rs.40 x 100000). … Read the rest

Some facts about the bonus issue of shares

BONUS ISSUE

When we invest the share capital in a business, we do so with the expectation of getting back not only our invested capital, but also a proportionate share of the surplus generated from operations, after all the other stakeholders have been paid their dues.  Thus, collectively the business owes its shareholders, their invested capital as well as the surplus generated from operations.  But in reality, while the business may pay us annual dividends, seldom is this surplus fully distributed away as dividends.  Thus, the surplus which is retained in the business is still owed to us.  This retained surplus is also reflected as retained earnings or reserves in the Balance sheet of a company.  Together, share capital and reserves are known as equity or the net worth of a company.

Over a period of time, the retained earnings of a firm can become quite large: often several times the original share capital.  And when this happens, the management of the firm may decide to transfer some amount from the reserves account to the share capital account by a mere book entry.  This has the effect of decreasing or debiting the reserves in the balance sheet of the firm and increasing or crediting the share capital (and hence the number of shares outstanding).  In such a case, the firm is said to have made a bonus issue.

THE BENEFIT OF A BONUS ISSUE TO A SHAREHOLDER:

Let us assume that a company makes a 1: 2 bonus issue.  In other words, for every two shares held, the shareholders receive one additional share. … Read the rest

Difference between debuntures and bonds

DEBENTURES

A debenture represents the smallest unit of public lending to a company.  Like shares, they are represented in the form of a certificate.  The common face value for a debenture in India is Rs.100, and they are always issued at par.  Unlike an ordinary shareholder, a debenture holder assumes very little risk on his investment.  Unlike the uncertain stream o dividends, which a shareholder receives, a debenture holder receives a fixed stream of interest.  Payment of such interest is a legal obligation on the part of the company.  Further, in general, a debenture is required to be secured against the assets of the company.  Thus, a debenture is also a form of a secured loan.  Secured debenture implies that should a company default in its obligations towards debenture holders in the repayment of their interest and principal, in law, the charged assets can be sold off for meeting such obligations.  Thus, debenture holders are investors who assume relatively little risk on their investment and accordingly the returns they can expect to earn are lower than that of ordinary shareholders.  Debenture holders, since they are lenders of capital and not owners, do not have voting rights, except under exceptional circumstances.  Unlike dividend, interest on debentures is deductible form the corporate profits.  This means that interest payments are made from the pretax operating profits of a company.

KINDS OF DEBENTURES IN THE CORPORATE SECTOR

Debentures are essentially of three kinds, fully convertible(FCD), partly convertible (PCD) and non-convertible (NCD).

  • Fully Convertible debentures (FCD) :- A fully convertible debenture is a debenture which, at a specified time after the issue, is fully converted to equity at the option of the holder.
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Why should a company try to price it’s public issue of shares as high as possible?

In fact, any company trying to price its public issue higher than its market price is being silly.  For that matter any company trying to price any of its products higher than the market price is being silly.  It should be obvious, that in such a case the investor (or the customer) will eject the offered share (or the product) outright, unless the higher price is qualitatively justified or he is ill informed.  True, there have been many instances following the free pricing policy where companies have priced their issues higher than the market price.  But these are errors of judgment, which a company soon comes to learn and learns to correct.  However, one important reason for the propensity of companies to price their shares unduly high may be attributed to their mistaken notion that the higher the price at which a company issues its shares, the lower its cost of capital.

Men who should know better, for example, our chief executives of companies and development banks, have frequently gone on record saying that under free pricing it is cheaper to raise equity than debt.  Such statements are made on the argument that while a debenture issue involves a cost of around 18% to 19%, the cost of raising equity can be as low as 3% (for example, when a company paying 30% dividend on a share with a par value of Rs.10 is issued at Rs.100, that is at or near the market price of the share).  According to this notion, the abolition Controller of Capital Issues (CCI – an official of the Ministry of Finance, a position now abolished) has reduced the cost of raising capital significantly. … Read the rest

Is free pricing of pubic issues are good or bad for investors

The answer depends upon whom we mean by “investors”?  Is investor the one who is already holding a share, that is, an existing shareholder, or one who is going to become a shareholder?  Unfortunately there has been some confusion in this regard.  To any reasonable person, it should be clear that is the existing shareholder who is the true investor since he has already invested.

Whenever a company makes a public issue of shares at a price, which is lower than the market value of the share, some part of the wealth gets transferred from the existing shareholder to the new shareholder.  It happens like this.  Consider a company with 1lakh shares outstanding, quoted in the market at Rs.50 each.  The total wealth of the existing shareholders can be said to be Rs.50 lakh.  If this company raises another Rs.10 lakh by issuing 50,000 shares at Rs.20 each, as used to be the case before free pricing, the share price of the company roughly falls down to Rs.40 (being (50 lakh + 10 lakh) / 105 lakh shares).  This means a loss of Rs.10 per share to the existing shareholders, amounting in all to Rs.10 lakh.

At the same time, this represents a gain to the new shareholders,.  Since their holding of 50,000 shares at the rate of Rs.40 each is now worth Rs.20 lakh and their investment was only Rs.10 lakh, the loss of 10 lakh to the existing shareholders becomes the gain to the new shareholders.

However, under free pricing regime, when a public issue of shares is made at the market price, say, Rs.40 in the above case, the existing shareholders suffer no net loss. … Read the rest

Introduction to stocks and shares

Stocks or securities are generic terms that stand for instruments of ownership like shares, as well as instruments of lending like debentures, which are issued publicly.  Just as a share represents the smallest unit of ownership, a debenture or a bond represents the smallest unit of lending.  Shares and debentures may be of various kinds.

An ordinary share represents the form of fractional ownership in which a shareholder (one who holds ordinary shares), as a fractional owner, undertakes maximum entrepreneurial risk associated with a business venture.  This risk has several dimensions.  During the life of a business, in general, an ordinary shareholder receives dividends out of operating surplus.  This surplus is the residual from the revenue, after subtracting all the operating expenses, the interest charges on all kinds of borrowing, various taxes, and dividends due to the non-ordinary shareholders.  Now, various economic factors, government policies, market conditions, the labour situation, management’s efficiency, etc. may affect revenues, expenses, interest, taxes, etc. in such a way that in any given period, there may or may not be adequate surplus left for ordinary shareholders.  Again, even when a business it at the verge of closing, all other stakeholders, such as employees, creditors, lenders, government, preference shareholders, etc. must be paid their claims first and only the residual can be shared by the ordinary shareholders.  Then, for various reasons, there may or may not be enough residual left for the ordinary shareholders are the last to receive their claims.  In this sense, ordinary shareholders are exposed to the highest risk amongst all the stakeholders in a business. … Read the rest