friend of mine owns the shares of Bata India [Get Quote].

When the company came out with a rights issue, she did not have a clue as to whether to opt for it or not. 

In fact, she wondered why they offered her the shares when she could buy it from the market whenever she wanted to.

Here's to demystifying what a rights issue is all about and how it affects you.

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The company needs money!

A company needs money to grow and expand -- to purchase new machinery, employ more people, buy more land, open new offices or even repay its loans.

To do that, an option to consider is to ask the public for money. There are three ways it can do so.

1. IPO

When a company comes out with an Initial Public Offering, it offers shares to the public. The public buys the shares and the company gets money. These shares are then listed on the stock exchange for the public to buy and sell. The investors will then get rewarded as the company does well and the value of their shares increases.

2. New issue

If a company that is already listed (has its shares listed on a stock exchange for buying and selling) is coming out with a fresh tranche of shares, it is called the new issue.

3. Rights issue

Sometimes, a company may come out with a fresh batch of shares but may choose not go to the public (as in a new
issue). It may just approach only the current shareholders (people who own the shares of that company).

This is called a rights issue.

What it means is that only the current shareholders have a right to buy these shares.

Simply put, rights issues are shares issued by a company only to its existing shareholders.

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What's not great about a rights issue

The shares do not come free of cost.

Bonus shares are offered free of cost. They are a gift. A bonus.

A rights issue will need you to buy the shares. They do not come free. 

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What's great about a rights issue

The good news is that the shares will be cheaper than the current market rate.

When a company offers new shares via a rights issue, it is usually at a discount to the current market rate.

What this means is that if the market price of the share is Rs 100, the company may offer the shares for Rs 90. So you get more shares at a cheaper rate than what you would get if you buy it from the market.

Let's take the example of the Bata India stock.

The price of the shares was moving between Rs 80 to Rs 90 when the rights issue was first announced in February. The price of each share in this rights issue was only Rs 54.  

However, after the announcement of the rights issue, the share price fluctuated widely between Rs 75 and Rs 100.

Generally, the price will go up because investors now want to buy the shares so that they can avail of the rights issue.

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Can I pick up however many shares I want?

No. that will not be possible. A rights issue is offered in proportion to your existing holding.

The company may come out with a 2 for 1 rights issue.
This will give the shareholder who has 1 share, the chance to buy 2 additional shares.

So, if you own 100 shares, you will get the chance to buy 200 additional shares.

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Who gets the rights issue?

The company will make an announcement that it is offering the rights issue to all shareholders (those who own the shares of the company) on a particular date. This date is called the record date.

After the rights announcement but before the record date, the shares are known as cum-rights. Even if you do not currently own the shares but if you buy them at that time, you will get the rights issue. On the record date, they become ex-rights. If you buy them after this day, you do not get the rights issue.

For instance, ING Vysya Bank [Get Quote] offered its shareholders three rights shares for every share held by them. On February 21, 2005, the rights issue was offered at Rs 45 per share.
 
The cum rights price of the shares (shares offered for sale with the associated rights) was Rs 597. If you bought these, the rights issue would have been applicable for you.
 
The ex-rights price adjusted to Rs 183. These shares are offered for sale without the rights. 

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What if I don't want the shares?

In a bonus issue, you are just given the shares and do not have a chance to say no (why would you say no
if they are free?).

In the case of a rights issue, you are given the option to decline (since you are paying for it).

You may refuse to subscribe to the rights issue and just let your "right" lapse. In which case you get nothing.

Or you can renounce your shares in favour of another person for a price.

In such a case, you can give anyone the rights free or sell it to him for whatever amount you agree on---all you have to do
is to sign the rights renunciation form.

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Summing up

In a bonus issue, the company will use its cash reserves to issue more shares. So the number of shares
of the company increases but the cash reserves decrease.

In the case of a rights issue, the company will be asking the shareholders for money. So the number of shares will increase here too but the money will be added to its kitty. 

Subscribe for a rights issue only if you really believe in the company.

Don't do it just because you are getting it cheaper.

Also, find out why the company is coming out with a rights issue. If it is to raise money for a sound business plan that will eventually increase the profits and share price, then it is a good bet.