Just wanted to know, what effect does rights issue have on stock price. Rights issue will increase the outstanding shares in the market but how does this affect CMP of the stock?
New shares issued in the rights issue increases the number of shares available and therefore have an impact on the price of the stock. The price can be theoretically derived using a mathematical formula known as Theoretical ex-rights Price (TERP):
The formula is as follows: TERP = (Rights share * Offer price + Existing shares * Market price) / Total number of shares
For example, if a company issues Rights in the ratio of 1:1. The rights price is Rs. 500 and the current market price is Rs. 1000. Theoretically, the total value of your current investment is expected to remain the same even if the rights share is added.
Value of your current investment + Price of rights = Value of your investment including rights benefit
1000 + 500 = 1500, where you have 2 shares (including the new rights share). Therefore, the theoretical current price of the shares on ex-date would be 1500/2 = Rs. 750
If the stock of the company also trades in the F&O segment, this will result in adjustments in F&O contracts. The adjustments are carried out in such a way that the value of your position remains the same before and after the ex-date. The exchange has explained the methodology for adjustments here.
To give you an example, Airtel recently announced the rights issue of shares in the ratio of 1:14, for which the ex-date was September 27, 2021. Snapshots from the exchange circular on how the adjustments were carried out.
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Well explained.Benefit to all.
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