Tuesday, April 18, 2006

What are bonus issues and stock splits?

Bonus Issues :

Instead of cash dividends, investors receive dividends in the form of a stock. The investor receives more shares when a bonus issue is announced. For example, when there is a bonus issue in the ratio of 1:1, the number of shares owned by an investor would double in number. However, the market price of the share would decrease as well. At times the decrease might not be proportionate to the extent of bonus because market players might push the price up if they view the bonus issue as a positive development. Some companies might announce bonus issues to bring the market price of its share to a more popular range and also promote active trading by increasing the number of outstanding shares.

Stock Splits :

Whenever a stock split occurs, the company ends up with more outstanding shares which will not only have a lower market price but also lower par value. Stock splits are prompted when the company thinks its stock price has risen to a level that is out of the "popular trading range".

For example,
X Corporation has 1 million outstanding shares. The par value is Rs.10/- and the current market price is Rs.1000/- per share. If the management feels this price is resulting in a decrease in trading volumes, they can declare a 1 -for-1 split. By doing this, there will be 2 million outstanding shares with a par value of Rs.5/- and a theoretical market price of Rs.500/- per share. Sometimes when the market price is very low, the company might announce a "reverse split" which has the opposite effect of the normal stock split.In the case of splits, there is no change in the reserves and surplus of the company unlike the bonus issue.

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