Series 7 practice questionhardEquity Securities — Rights Offering — Scenario
A company has 10 million shares outstanding and issues rights allowing shareholders to buy 1 new share for every 5 shares held at $30. The current market price is $40. An investor who holds 1,000 shares decides not to exercise. What is the likely financial impact?
- AThe investor's proportional ownership is diluted and they lose the value of the unexercised rights✓ Correct answer
- BNo impact, since rights have no value
- CThe investor receives extra dividends to compensate
- DThe stock price increases to offset the dilution
Explanation
Why A — The investor's proportional ownership is diluted and they lose the value of the unexercised rights
When an investor does not exercise rights, their ownership percentage decreases as new shares are issued to other shareholders who do exercise. Additionally, the rights themselves have intrinsic value (the market price of $40 minus the subscription price of $30 = $10 value per right, adjusted for the ratio). The investor loses both the proportional ownership and the economic value of the rights.
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