Bonus Issue

Dividends are paid to shareholders to distribute profits made by organization every year (or each quarter) in monetary terms. When such dividend are paid in terms of stock it is termed as 'Bonus Issue'. It is an organization's reward to the shareholder and are issued out of the reserves.

Every shareholder receives these free shares in a certain ratio to the shares that he/she is currently holding. This ratio is announced by organization. If the ratio is 1:1 then the existing shareholder will get 1 additional share for every 1 share he/she holds in the organization at no additional cost. Similarly if the ratio is 1:2 then the existing shareholder will get 1 additional share for every 2 share he/she holds in the organization again at no additional cost.

Consider a shareholder owns 100 shares of an organization which has announced bonus in ratio of 1:2 and is currently trading at Rs.300.

Current Value of Investment=100 shares*Rs.300/share=Rs.30,000

then he/she will be issued additional 50 shares.

Bonus Shares=Number of shares held*ratio=100*(1/2)=50

,so his total holding will become 150 shares (=100+50). When the bonus shares are issued, the number of shares the shareholder holds will increase, but an investment’s overall value still remains same as the share price adjusts itself the day additional shares are credited.

Share price=(Value of Investment prior bonus/Number of shares held after bonus)=30000/150=Rs.200/share

But most of the times it is found that shares trade at a premium to the above calculated value after bonus. Moreover a positive rally in stock price is also observed in week(s) preceding the day bonus shares are credited in most cases.