What is a 'Theoretical Ex-Rights Price'?

A theoretical ex-rights price (TERP) is the market price that a stock will theoretically have following a new rights issue. Although the stock price is not likely to change immediately following the new rights issue, it will change as the rights' expiration date approaches. The theoretical ex-rights price is based on the company's market capitalization and the number of shares outstanding.

BREAKING DOWN 'Theoretical Ex-Rights Price'

For example, if a new rights offering gives buyers the right to purchase 25% more shares than there are currently outstanding, the market price of the stock will theoretically be 25% less in the future than it is today assuming 100% of the new rights will be exercised by the holders.

Shareholders use the TERP to determine the estimated value of the shares after the rights issue. This amount will differ from the current market price. The TERP determines the change in value across all stocks (current and newly issued) after the creation is complete and assuming all rights to purchase are exercised.

It is possible for multiple theoretical values to be obtained for the same stock depending on the exact method employed to calculate the estimate and any changes in market conditions between the time one estimate is calculated and another. This variance occurs because, as shares are bought or sold, the market value fluctuates.

Understanding the Rights Issue

When an organization chooses to offer additional stock offerings to drive revenue, current shareholders are given an opportunity to purchase a portion of these new shares at a discounted price for a specified period. The portion each shareholder is allowed to purchase is proportional to that shareholder's current stake in the organization. The idea is to give current shareholders the opportunity to maintain their current percentage stake in the organization at a discount price although this right does not have to be exercised.

Calculation of a Theoretical Ex-rights Price

A simple way to create a TERP estimate is to add the current market value of all shares existing before the rights issue and the funds raised as a result of the rights issue sales. This number is then divided by the total number of shares in existence after the rights issue is complete to give an estimate of the value of an individual share after the transaction.

Investor Analysis

Once the TERP is calculated, investors can compare that value to the current value of a share (before the rights issue) and assess whether the market price will once again rise to the pre-rights level. Typically, shares purchased during a rights issue are offered at an amount below the current market value of the stock although the price does rise gradually as the rights period approaches expiration.

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