Whenever shares are bought before exdate the buyer is entitled to receive the rights. Because of the time difference between buying and actual settlement, the rights are credited to the counterparty of the trade and hence the rights need to be transfered.
DEVELOPMENT OF THE SHAREPRICE
Please find below a description of the effects Rights Issue events can have on the share price in the market. For the calculations the following assumptions are used:
1) the investor holds 100,000 shares in company "ABC" before the rights issue event takes effect
2) the market price of the shares before the event = EUR 5.00
3) the nominal value of the shares before the event = EUR 1.00
Rights Issue (ratios: 1 right for every 1 share, 10 rights entitle to buy 1 new share for EUR 4.00)
In the example the sharehoder will receive 100,000 rights based on his holdings of 100,000 shares. With those 100,000 rights he is entitled to buy an additional 10,000 new shares at a subscription price of EUR 4 per share.
Value of his holdings before the rights issue: 100,000 x EUR 5.00 = EUR 500,000.
Value of his holdings after the rights issue:
100,000 x EUR 5.00 = EUR 500,000.
10,000 x EUR 4.00 = EUR 40,000
value of 110,000 shares: EUR 540,000
Theoretical market price after the exdate of the rights issue: EUR 540,000 / 110,000 = EUR 4.91 per share.
The theoretical value of every right equals therefore: EUR 5.00 - EUR 4.91 = EUR 0.09. In reality however, the right issue takes place over a period of time in which the value of the shares will change and hence the value of the rights will change accordingly.
Please note that every shareholder has got 4 basic option in a rights issue event:
1) Take No Action and let the rights lapse worhtless.
please note that under this option the value of his holdings decreases from EUR 500,000 to EUR 491,000. Put differently: he loses 100,000 x (EUR 5.00 - EUR 4.91) = EUR 9,000.
2) Sell the rights.
Under this option he will not lose any value if he manages to sell his rights for at least EUR 0.09 each.
3) Exercise the rights in order to subscribe to 10,000 new share for a total amount of EUR 40,000
In this case the value of his original holdings stays the same, however, he needs to invest an additional EUR 40,000 to achieve this.
4) buy (and subsequently exercise) additional rights from other shareholders. In this case the shareholder could make a profit if he manages to buy the rights for less than EUR 0.09 per right.
Combinations of the options mentioned above are possible as well.
The above are THEORETICAL calculations only. In reality, a rights issue will take place during the course of a couple of weeks and the share price is subject to several factors, like developments in underlying operations, macro-economic data and market sentiment. Also a shareholder needs to be confident that the management of the company will find good use for the extra money.
(Please note that any investment decicions made based on the content of this site are entirely at the reader's risk only. Please also note the disclaimer)
SETTING THE EXERCISE PRICE
The company is interested in raising as much money as possible and therefor in theory would like to set the exercise price as high as possible.
Shareholders and underwriters on the other hand will be interested in an exercie price that gives a substantial discount to the market. If the exercise price is too close to the market price of the securities, than investors have no real incentive to subscribe to new shares in the event (they can buy the same shares in the market for the same price).