Theoretical Ex-Rights Price (TERP): Comprehensive Definition and Analysis

Explore the concept of Theoretical Ex-Rights Price (TERP), understand its calculation following a rights issue, and its significance in trading and investment.

The Theoretical Ex-Rights Price (TERP) is an estimated market price at which a stock is expected to trade following a new rights issue. TERP helps investors understand the dilution impact and how the stock price will adjust once the new shares are issued.

Calculation of TERP

The TERP is calculated using the formula:

$$ \text{TERP} = \frac{(N \times P) + (R \times S)}{N + R} $$

where:

• \(N\) = Number of old shares
• \(P\) = Market price of the existing shares before the rights issue
• \(R\) = Number of new shares issued
• \(S\) = Subscription price of the new shares

Example Calculation

Assume a company has 1,000,000 shares outstanding, trading at $10 per share, and announces a rights issue of 200,000 new shares at $8 per share. The TERP calculation would be:

$$ \text{TERP} = \frac{(1,000,000 \times 10) + (200,000 \times 8)}{1,000,000 + 200,000} = \frac{10,000,000 + 1,600,000}{1,200,000} = \frac{11,600,000}{1,200,000} = 9.67 $$

After the rights issue, the stock’s TERP is expected to be $9.67.

Significance of TERP in Trading and Investment

TERP provides critical insights for investors:

• Assessing Dilution: It helps in understanding the share price dilution due to the additional shares.
• Informed Decision Making: Investors can make better decisions on whether to participate in the rights issue.
• Market Expectations: It aligns investor expectations about the post-issue trading price.

Historical Context and Applicability

Rights issues have a significant historical relevance as a method for companies to raise additional capital. They offer existing shareholders the opportunity to maintain their proportional ownership and prevent dilution.

Comparisons with Related Terms

• Ex-Rights Date: The date on which a stock trades without the rights attached.
• Cum-Rights: The state of a stock when it still includes the benefit of the upcoming rights issue.
• Subscription Price: The price at which the new shares are offered to existing shareholders.

FAQs

What is the impact of TERP on stock prices?

TERP provides an adjusted price, reflecting the expected market value post-rights issue, accounting for new shares’ dilution effect.

How important is TERP for individual investors?

TERP is crucial for individual investors to make qualification decisions during a rights issue, ensuring they understand potential value shifts.

Can TERP predict future stock movements?

While TERP gives an informed estimation, it cannot predict exact future movements, as it doesn’t factor market sentiment or corporate actions post-rights issue.

Summary

The Theoretical Ex-Rights Price (TERP) is essential for understanding stock price behavior post-rights issue. It promotes informed investment decisions and aids in anticipating market adjustments due to the dilution effect. Recognizing and calculating TERP helps investors navigate corporate actions strategically.

References:

1. Bryer, R.A. (2003). “The Rights Issue Process.” Journal of Finance.
2. Smith, C.W. (1977). “Alternative Methods for Raising Capital by Rights or Public Offerings.” Journal of Financial Economics.

By comprehensively understanding TERP, investors can better manage their portfolio strategies during rights issues.