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Monday, September 15, 2008

How to exercise your rights

Several large rights issues from companies like Tata Motors, Hindalco, Tata Investment will be hitting the market in the near future. Recent entrants to the stock market, like my young friend Bala, may not have a clear idea about what to do with a rights issue.

Once you receive the rights issue application form and the offer booklet from the company, go through the details of the offer. Special attention should be given to the details about how much to pay, when to pay, where to pay and what to write on the cheque. Any mistakes can cause your application to be rejected.

Several options are available to the investor. These are listed below:

1.  Apply for your entire entitlement; e.g. if your entitlement is 42 shares, this figure will be clearly mentioned in the application form; just fill out the form and pay the application money for the 42 shares

2. You may apply for additional shares in the box provided in the form; e.g. apply for 8 additional shares and pay your application money for (42+8=) 50 shares; chances are you will get allotment for the 50 shares because the market is in a bear phase and many investors may not apply for additional shares. Don't get greedy and apply for 52 additional shares. You may then get an allotment of say 17 shares and be left with an odd number of 59 shares (which may be difficult to sell later in one lot)

3. You can apply for less shares than your entitlement; e.g. apply only for 25 shares and let the balance entitlement of 17 shares lapse

4. You may 'renounce' your entire entitlement in some one else's favour, like your broker or your friend. You will usually get a monetary consideration for your renouncement, say Rs 8 per share.

5. You can request the company for split forms, i.e. 25 shares in one and 17 shares in another. That way you can apply for 25 shares and 'renounce' the balance 17 for a consideration of say Rs 8 per share

6. You can decide not to do anything at all and let your entire entitlement lapse.

Why would you choose this last option? In a falling market the difference between the market price and the rights price may not be large enough. After the rights issue is over, the market price may even drop below the rights issue price. So you may be better off to buy the shares at market price after the rights issue is over if you feel the rights price is not leaving a large enough margin of safety.

Investors who participated in the recent rights issues of ICICI Bank and State Bank will know what I'm talking about.

There is a recent move by SEBI to make rights issues paperless, but as on date it remains a proposal only. If readers have any questions on rights issues, please send me an email with your specific query ( or leave a comment on the blog).

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