What is 'Theoretical Value (Of A Right)'
The theoretical value (of a right) is the value of a subscription right; during the cum rights period — the period of time between the announcement of the rights offering and when the stock trades on an exercise of rights basis — the value of the right is calculated using the following formula:
(Stock Price - Rights subscription price per share) / Number of rights required to buy one share + 1
BREAKING DOWN 'Theoretical Value (Of A Right)'Typically, the theoretical value and the market value of a right are the same or very similar. It is also known as the intrinsic value of the right.
Real-World Example of Theoretical Value of a Right
Consider this example: the current price of a stock is $40, the exercise price (or subscription price) is $35 and four rights are required to purchase a share. The theoretical value of the right is: ($40 - $35) / (4 + 1) = $1. The theoretical value during the exercise of rights period — when rights trade independently of the stock — differs from the value during the cum rights period. The calculation for this is: (stock price – right subscription price) / number of rights needed to buy a share). If, continuing the above example, the stock price during the ex-rights period is $38, the theoretical value of the right would be ($38-$35) / 4 = $0.75.
A right’s value is calculated using the same parameters used for pricing options, including the rights subscription price, prevailing interest rates, time to expiration, and the share price of the underlying stock, taking into consideration the level of its volatility. The major difference is that rights have significantly less time value than most options because of their comparatively short lifespan.
Theoretical Nil Paid Price
If an investor chooses to sell his right outright in the market, or if he chooses to let the right lapse, which may result in a minimal administrative charge, he will receive the theoretical nil paid price of the right. This value is calculated by determining the difference between the subscription price the investor paid and the theoretical ex-right price.
Considering the example used above, the calculation for a theoretical nil paid price looks like this: $40 - $38 = $2. Thus, the amount the investor would receive for the right is twice the value of the right during the cum rights period and even greater than the value of the right during the ex-rights period.