Share swap

An acquirer does not always pay cash for a target company. Instead, it can pay with its own shares — handing the target's shareholders a stake in the combined, larger business.

That exchange is a share swap. Both companies must agree on relative values first, because that valuation is exactly what sets the exchange ratio.

The workbook: a share swap simply "means exchanging one set of shares with another set of shares." It is most often used during a merger or acquisition, where the acquiring company uses its own stock instead of cash to pay for the target.

Before the swap happens, each of the 2 companies must be independently valued, because that valuation is exactly what fixes the exchange ratio the deal runs on.

Illustrative. Company A acquires Company B in a share swap agreed at a ratio of 3 shares of A for every 5 shares of B, based on independent valuations of Rs 500 a share for A and Rs 300 a share for B.

Fairness check: 5 × Rs 300 (B) = Rs 1,500 = 3 × Rs 500 (A)

A shareholder holding 1,000 shares of B receives 1,000 × 3 ÷ 5 = 600 shares of A once the swap completes, and no cash changes hands at all.

Chapter 9.13 (Share Swap) sets out the mechanism. Expect a question computing shares received under a stated swap ratio, or one testing why both companies must be independently valued before the ratio is fixed.

• The direction of the ratio matters. "3 shares of A for every 5 of B" is not the same as "5 shares of A for every 3 of B" — applying the ratio backwards is the most common numeric error.