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Lesson 6. Stock Derivatives > Warrants - Pg. 28

Stock Derivatives 28 XYZ Company certainly doesn't want to cause hard feelings in those people who already own its stock, because a sell-off by angry shareholders could lower the price of the stock, and the company would thereby effectively lose all the money it had stood to gain by issuing new stock. To address this type of situation, XYZ Company decides to issue subscription rights to its current shareholders. By issuing subscription rights, XYZ Company gives its investors "coupons" with which they can buy shares of the newly issued 200 shares for $8 per share rather than the $10 everyone else has to pay. These coupons, or subscription rights, are usually issued based on the number of shares already held by the current investor. In the same example, you own 100 shares, and XYZ Company has decided that for every 5 shares held by a current investor the investor will be issued one subscription right. You therefore have the right to purchase 20 shares for $8 each. If you buy 20 additional shares at $8, it will cost you $160. That's a big break from the $200 it would cost a new investor to purchase those same 20 shares at $10 per share. And the value of your new shares is still $200, just as if you had paid the new-investor price of $10 per share. Thus you im- mediately make $40. Immediate Gratification The advantage of subscription rights is that you can make money from them even if you have no interest in purchasing additional stock. Let's say XYZ issues you 20 subscription rights and, truth- fully, you have no intention of using them. Then let's say I'm an investor who wishes to purchase XYZ Company stock. You offer to sell me your 20 subscription rights for $1 each. Yes, you can do that because subscription rights are fully transferable; in other words, you can use them or dispose of them as you see fit. I pay you $20 for your subscription rights and then buy the 20 shares at $8 each (20 × $8 = $160). Adding in the $20 I paid you initially, my total price is $180. I still got the stock $20 cheaper than if