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A number of companies issue bonus shares for their shareholders in order to increase the liquidity of the stock or decrease its stock price. These are basically fully paid additional shares issued by a company to its pre-existing shareholder.

Earlier today, the Indian Energy Exchange (IEX) informed the bourses that the company’s board will meet on October 21 to consider a bonus issue of equity shares. Post the announcement, the company’s stock rallied as much as 20 percent to hit its 52-week high of 956.15.

“We wish to inform you that the Board of Directors of the Company in their meeting scheduled on Thursday, October 21, 2021, shall inter-alia, also consider the proposal for declaration of Bonus Issue of Equity Shares subject to the approval of the shareholders of the Company," the exchange informed in a BSE filing today.

When a firm issues bonus shares, its shareholders do not have to incur any extra costs to get them. The number of bonus shares you receive depends on the number of shares of the firm you already hold.

So why does a company then issue these free, additional shares?

This is mostly done to increase the liquidity of the stock. When the price of a share is high, a number of retail investors may find it difficult to buy that share. By issuing bonus shares, the total number of shares of the firm increases, thus reducing its stock price and making it accessible to more investors. With more shares in the market at a low price, the liquidity and investor engagement of the shares improve considerably.

A number of times, companies also issue bonus shares when they do not have enough cash to pay dividends to the shareholders despite a profit. It is also done by some firms to avoid paying high dividend distribution tax. In place of a dividend, which is regularly given, it issues extra shares to its investors as a bonus.

So how does it work?

The company issues these shares in a particular ratio. Suppose a 1:1 bonus issue is announced. It means for everyone shares a person holds, he/she will get one additional share. Say you hold 20 shares in a firm and it issues a 1:1 bonus share, you will receive 20 extra shares in your Demat account.

Similarly, suppose a firm has announced a bonus share of 4:1, then for every 1 share, the shareholder will receive 4 more. So if you own 20 shares, you will get 4*20 which is 80 additional shares.

Who is eligible?

All shareholders who own shares of the firm before the ex-date, which is determined by the firm, are eligible for bonus shares.

When announcing a bonus issue the company also informs the shareholders regarding a record date. It is the cut-off date set by the company.

India follows a T+2 rolling system, which means the ex-date is 2 days before the record date. An investor, if he/she wants to be eligible for the bonus issue must buy shares before the ex-date. Anyone who buys the stock on the ex-date will not be eligible for this.

The bonus shares are then credited to the shareholders' accounts within fifteen days after a new ISIN (International Securities Identification Number) is assigned to them.

Bonus issue and share price

Suppose the stock price is 200 before the bonus issue and the total shares are 100. The bonus ratio announced by the firm is 1:1 (meaning bonus 1 share for every 1 share held). Now, after the bonus issue, the number of shares will double, which is 200.

So now if the share price of the company before the bonus issue was 200, it will decrease as the number of shares increase.

New share price = Stock price * old shares/ new shares = 200*100/200 = 100.

So the share price halved after the bonus issue. However, the value of an investment for any shareholder does not decrease in case of a bonus issue. If you held 2 shares before the bonus issue, which means the value of the investment was 400 (stock price * shares held).

After the bonus issue, you hold 4 shares. Even though your stock price decreased from 200 to 100, the number of shares also increased to 4 from 2. Your value of investment post the bonus issue remains the same, which is 400.

Companies generally issue bonus shares to increase retail participation and increase the liquidity of the stock. While it also leads to a decrease in stock prices, it is a great opportunity for investors to accumulate shares.

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