BAJAJ BROKING
July 11, 2024
10 mins read
This article explains Rights Entitlement (RE) as an option given to existing shareholders to purchase additional shares in a company's rights issue. It explains rights issues, the role of RE, and how shareholders can participate in them. It also highlights the importance of understanding the process and the timelines involved in the trading of REs.
Investing in the stock market offers exciting opportunities, but it can also be complex, especially for new investors. One concept that often causes confusion is Rights Entitlement. Rights Entitlement (RE) is a tradable instrument that allows existing shareholders to subscribe to a company’s rights issue. It represents the right to buy additional shares at a predetermined price before a specified deadline.
In this article, we’ll explain what Rights Entitlement is, how it works, and why it matters. You’ll learn how REs impact your investment strategy, whether to subscribe or trade them, and how they can offer potential opportunities in the stock market.
Rights Entitlement (RE) is a special privilege given to existing shareholders of a company. When a company needs to raise more capital, it can issue additional shares to its current shareholders through a process called a rights issue. Rights Entitlement allows shareholders to buy these new shares at a discounted price before they are offered to the public. It is a way for the company to reward shareholders for their loyalty.
What is rights entitlement and why should investors consider it? Rights entitlement provides an excellent opportunity for shareholders to increase their stake in a company at a discounted price. This process allows existing investors to maintain their ownership percentage while benefiting from lower acquisition costs. By leveraging rights entitlement, shareholders can gain additional shares without participating in the open market, ensuring a cost-effective method of portfolio expansion.
A significant advantage of rights entitlement is the ability to purchase shares at a lower-than-market price. When a company announces a rights issue, it offers shares to eligible shareholders at a predetermined discount. This allows investors to acquire more shares at a price lower than the prevailing market rate, giving them a competitive edge. Additionally, rights entitlement ensures that shareholders can participate in a company's growth without excessive capital outlay.
Another reason to opt for rights entitlement is the flexibility it provides. Investors are not obligated to buy additional shares; instead, they can choose to sell their rights entitlement on stock exchanges. This feature allows those who do not wish to subscribe to monetize their entitlements by selling them at market-driven prices. As a result, shareholders have multiple options—subscribe, trade, or renounce—making rights entitlement a dynamic investment tool.
Furthermore, rights entitlement helps companies raise capital efficiently while giving investors an opportunity to support business expansion. Companies often issue rights to fund acquisitions, reduce debt, or invest in new projects. By subscribing to rights entitlement, investors contribute to the company’s financial health while securing their stake at an attractive valuation. This mutually beneficial process strengthens shareholder-company relationships and ensures long-term value creation.
Finally, the introduction of rights entitlement trading has enhanced liquidity in financial markets. Since investors can buy and sell their rights entitlement, the process has become more seamless and accessible. This trading mechanism ensures that shareholders can capitalize on their rights without mandatory participation in the issue. With these advantages, opting for rights entitlement is a strategic move for investors looking to enhance their portfolio while maximizing value.
When a company announces a rights issue, shareholders receive Rights Entitlements in their Demat accounts. These REs represent the right to purchase additional shares at a discounted rate. Think of it as a coupon that gives you the option to buy more shares at a lower price.
For example, if you own 100 shares of a company, and the company announces a rights issue in the ratio of 1:5, you will receive 20 REs. This means you have the right to buy 20 additional shares at the discounted price.
Rights entitlement trading is a process that allows shareholders to transfer their rights to another investor through a stock exchange. Since rights entitlement is electronically credited to eligible shareholders' Demat accounts, investors can either subscribe to the rights issue or sell their entitlements in the open market. This flexibility provides an opportunity for shareholders who do not wish to participate in the rights issue to still derive value by selling their rights entitlement at a market-driven price.
The trading of rights entitlement follows a process similar to equity trading, with a few key differences. The price of rights entitlement is determined by the stock's closing price on the issue opening date minus the right issue price. Once trading begins, market supply and demand dictate further price movements. Investors can buy rights entitlement if they wish to participate in a company's rights issue but were not eligible based on the record date.
One of the major advantages of rights entitlement trading is the enhanced liquidity it provides. Unlike in the past, where unutilized entitlements would lapse, shareholders can now sell them and monetize their holdings. Additionally, investors who missed the record date but see potential in a rights issue can purchase rights entitlement from the secondary market, ensuring broader participation.
If an investor chooses not to apply for rights entitlement, their entitlement will expire at the end of the trading window, rendering it worthless. Unlike regular shares, rights entitlement has a limited validity period, and failure to act within the specified timeframe results in forfeiture. This means the shareholder not only loses the opportunity to subscribe at a discounted price but also misses out on potential gains from trading the entitlement in the secondary market. Additionally, if the shareholder does not apply, their ownership stake in the company may be diluted as new shares are allotted to others. Therefore, it is crucial for investors to either subscribe or trade their rights entitlement to avoid financial loss.
The rights entitlement share price is determined based on the difference between the market price of the stock and the offer price of the rights issue. Since rights entitlement is a tradable instrument, its value fluctuates based on market demand and supply. Investors who receive rights entitlement can either subscribe to the offered shares at a discounted price or sell their entitlements in the secondary market. The base price of rights entitlement is calculated as:
Rights Entitlement Share Price (Base Price) = Closing price of the stock on the issue opening date – Rights Issue Offer Price
Key factors influencing rights entitlement share price:
Market Price of the Stock: A higher stock price increases the potential value of rights entitlement, making it more attractive to investors.
Rights Issue Offer Price: The lower the rights issue price, the more valuable the entitlement becomes.
Market Sentiment: Demand and supply forces in the secondary market affect the price, leading to fluctuations beyond the base calculation.
Subscription Interest: High participation from existing and new investors can drive up the price of rights entitlement.
Investors should carefully evaluate these factors before making decisions regarding their rights entitlement to maximize potential benefits.
Now, as a shareholder, you have three options when you receive Rights Entitlements:
Rights Entitlements can be traded on the stock exchange, just like regular shares. This trading period is usually short, often lasting just a few days. During this time, you can buy or sell REs depending on your investment strategy.
Trading REs allows shareholders who do not want to subscribe to the rights issue to still benefit from the opportunity. By selling REs, you can potentially make a profit, while buyers can purchase these entitlements if they missed the original allocation.
Participating in a rights issue through REs can offer several benefits:
When dealing with Rights Entitlements, timing is crucial. Here's a typical timeline:
If you decide not to subscribe to the rights issue, you can renounce (transfer) your Rights Entitlements to someone else. This is usually done for a price, allowing you to benefit even if you don't want to buy more shares. Renouncing can be done during the trading period mentioned above.
Renouncing your REs can be beneficial if you believe that the price of the shares will not rise significantly or if you need immediate liquidity. By selling your REs, you can get some returns instead of letting them lapse.
Rights Entitlement is a valuable opportunity for shareholders to increase their investment in a company at a discounted price. By understanding how REs work and the options available, you can make informed decisions that align with your investment goals. Whether you choose to subscribe, sell, or let your REs lapse, being aware of the process and timing can help you maximise your benefits. Remember, every investment decision should be based on thorough research and alignment with your financial objectives.
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Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Rights entitlement is allocated based on the number of shares an investor holds on the record date. Companies determine an entitlement ratio (e.g., 1:10), meaning shareholders receive rights entitlement in proportion to their holdings. These entitlements are credited electronically to eligible investors' Demat accounts.
Eligible shareholders can exercise their rights entitlement by applying through their Demat account. They must use the ASBA (Application Supported by Blocked Amount) facility or apply via the company's designated portal. Investors can either subscribe fully, partially, or renounce their rights entitlement through trading on stock exchanges.
Yes, rights entitlement can be transferred to another investor via stock exchanges. Shareholders unwilling to subscribe to the rights issue can sell their rights entitlement in the secondary market. Transfers must occur within the specified trading window, ensuring eligibility for rights subscription by the new holder.
If an investor lacks funds to subscribe to rights entitlement, they can sell their entitlements in the secondary market. Failing to act results in entitlement expiration without compensation. Investors should evaluate financial readiness before deciding whether to subscribe or trade their rights entitlement.
No, rights entitlement applies only to companies opting for a rights issue. Listed companies use this method to raise capital from existing shareholders. However, not all companies conduct rights issues, as they may prefer alternate funding sources such as debt issuance or public offerings.
Taxation on rights entitlement varies based on usage. Selling rights entitlement in the secondary market attracts capital gains tax. If subscribed, tax applies upon selling the acquired shares. Investors should consult a tax advisor for precise implications based on their investment decision.
Rights entitlement issuance may temporarily impact share prices. Since new shares are offered at a discount, stock prices often adjust accordingly. However, long-term effects depend on company performance, investor sentiment, and the purpose behind the rights issue, influencing overall valuation.
No, rights entitlement expires if not exercised within the specified period. Investors must subscribe or trade their entitlements before the deadline. Once expired, entitlements cannot be reclaimed or applied for, leading to a loss of the opportunity to purchase discounted shares.
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