Questions:
What is the meaning of stock rights? There are companies listed in the PSE who have declared stock rights and I do not know what is the implication of this in relation me, as I own some shares. -- Jane Nataya

I just want to know more about warrants and stock rights. I came across the term when I was setting up an event at the office where a free warrant was being discussed for every 2 rights share. -- Miko Ibarra

The term “stock rights” is rather literal. What it refers to is the right to buy additional shares in a company. This right is extended only to existing shareholders of the company and not to potential new shareholders.

The additional shares being offered by the company under the stock right is priced at a discount over the current market price. Since the shares of the company can be bought in the open market at the market price (and no one will obviously buy shares at a price higher than the market price — unless they know something the rest of us don’t), this is the only way the stock rights can be an attractive investment and have market value.

By offering stock rights, the company simply wishes to raise more capital. Limiting this right to existing shareholders gives the shareholders basically the option to have more stake in the fortunes of the company. It is important to remember that it is a “right” but the shareholder is not obligated to invest more. This right also expires by a certain deadline so the shareholder needs to decide within a fixed period. In this sense, the stock right just gives the shareholder the right of first refusal. Should the company need to raise more capital after the rights expire, it can then invite new shareholders with additional shares (assuming that the authorized capital has not been fully issued & subscribed).

Stock rights also come with the added feature where the company sets the amount of shares that can be purchased under the stock rights in relation to the amount of shares the investor already has. In this way, the total capital of the company may be expanding but the relative shares among shareholders need not be affected drastically. In short, the intent is to make the capital pie larger without necessarily changing the way the slices of the pie are cut among existing claimants to the pie. Otherwise, the exercise gets complicated because not only is more money involved, the balance of power may also be at stake.

Aside from issuing stock rights, a company may also sell warrants to raise some funds. Here we are already treading into complicated financial transactions (a warrant is a financial derivative) so let me try to explain this carefully.

Warrants are instruments by themselves and therefore legally involve some financial claims. In this case, the object of the claim is the shares of stock of the company issuing the warrant although the claim itself can be exercised by the warrant-holder only at some future point in time.

Unlike stock rights, warrants are priced above the current market price of the shares of the company at issuance. Investors who buy a warrant basically believe that the price of the stocks of the company will rise above the warrant price at that specified point in time in the future. If this happens, the warrant-holder then can exercise his/her claim as specified in the warrant.

Why would investors buy an instrument whose price is above the current price of shares of stock that effectively underlie the instrument?

Well, that is the nature of the financial bet. If at the reckoning date in the future, the share price of the stocks rise above the price at which the warrant was bought, the investor “exercises” the claim of the warrant, gets the number of shares identified in the warrant, sells the shares in the open market and makes a profit. The profit comes from the difference between the higher share prices in the future and the cost of the warrant in the past that was based on the company’s stock price when the warrant was issued.

Of course if the stock price in the future does not go higher than the warrant’s price, the right of claim provided by the warrant is not exercised by the investor and is left to expire. In this case, the investor loses by the amount it cost to buy the warrant.

The company issuing stock rights or warrants is really not directly affected by the profits or losses made by investors. As far as they are concerned, these instruments provide a means to raise funds for the use of the company. The profits and losses that accrue to the investor refer to investment gains and losses of the investor in managing the instruments and do not reflect gains and losses of the company itself.

This is why the market makes a distinction between “underlying” and “overlying” instruments. The price of the underlying is simply used as a measuring stick for the performance of the overlying (i.e., the warrant and the stock right).

But it should be clear that the gains that investors make with the overlying does not come at the expense either of the underlying instruments or the company itself. More importantly, an investor can experience losses with overlying but this does not automatically mean that the company issuing the rights (be it warrants or stock) is also experiencing losses.

(Have a question for Dr. Noet? Email personal_finance@inquirer.net)

(Noet Ravalo is a macro-financial economist by practice and profession. He was chief economist of the Bankers Association of the Philippines until 2002 and has since been doing consulting work for multilateral and foreign agencies. His current engagements are with the Bangko Sentral ng Pilipinas and the PDS Group. Over the past 12 years, he has been asked to provide technical inputs to both the Senate and the House of Representatives on various economic and financial legislation, some of which will have big impact on Filipinos’ personal finances.)

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