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TERP Definition – Formula – What is the Theoretical Ex-Rights Price?

TERP – What Is the Theoretical Ex-rights Price?

TERPTERP is the Theoretical Ex-rights Price of a company’s shares following a rights issue. It is usually calculated as the weighted average price of the combined existing and new company shares.  A rights issue happens when a company issues new shares for cash to the current shareholders. Rights shares are issued at a price slightly below the market price of the company’s prevailing shares. This is done to encourage the existing shareholders to purchase the shares while generating cash for the company.

As a result, TERP is the estimated market price that a stock will theoretically have following the new rights issue. Companies sometimes issue new rights shares to existing shareholders as a benefit and to generate cash. Ultimately, stock prices are affected by a new rights issue because it increases the number of shares outstanding.  Because the shares are offered at a discount, this will usually lower the overall share price to some extent.

TERP – Theoretical Ex-rights Price Analysis

A theoretical ex-rights price is the estimation of the value of new stock issued through a rights offering. Typically, rights offerings are only available for current shareholders and only offered for a short time, usually 30 days. Rights offerings give shareholders the option to buy a proportional number of shares at a discounted, pre-specified price. The number of shares each shareholder is allowed to purchase is based on the current number of shares each investor currently holds. The purpose is to raise additional capital while giving preferential treatment to current shareholders.

Stock rights offerings can be popular for investors and traders.  This is because they may create potential arbitrage opportunities through the rights offering period. Overall the rights offering period can inhibit efficient market trading and create uncertainty over the stock’s ultimate price. Generally, stock rights offerings are a way for management to raise capital through the company stock. Stock rights offerings have the added benefit of generating additional interest in a company’s stock. New rights offerings are commonly offered at a discounted price.  As a result, this will usually dilute the stock’s price to some extent. As a result, the TERP is usually lower than the pre-offering market price.

Investors can compare the TERP to the current value of a share and speculate about future market appreciation. Since rights are offered at a discounted price, the more rights exercised, the more the stock’s price becomes diluted. However, throughout the rights offering period, supply and demand still affect the market price. Even though dilution is occurring, investor demand can still increase the prevailing market price. Investors who are bullish on the stock may be more motivated by the offering.  Conversely, bearish or short-term investors may not see as much upside.

Why Calculate TERP – Theoretical Ex-rights Price?

During a rights issue, a company raises capital by offering new shares of its stock to its shareholders. In theory, the shareholders will buy all the new offerings, and this trade will change the price of the company’s shares. The theoretical ex-rights price estimates the shares’ financial value after the trade, showing shareholders if it is worth exercising their rights to buy new shares or not.

TERP Formula

The simplest way to create a TERP estimate is to add the current market value of all shares existing before the rights issue to the total funds raised from the rights issue sales. This number is then divided by the total number of shares in existence after the rights issue is complete. This calculation results in the value of an individual share after the offering.  The simple weighted average formula to estimate theoretical ex-rights price is:

TERP = [(New Shares × Issue Price) + (Old Shares × Market Price)] / (New Shares + Old Shares)

TERP Calculation Example

A 1 for 1 rights issue is announced by Company ABC at $22 for each new share issued.  The current market price for Company ABC’s stock is $25.  The TERP or estimated price per share after the shares have been purchased by the current shareholders is as follows:

Solution

TERP = (1 x $22) + (1 x $25) / 1 + 1 = $47 / 2 = $23.50 per share

Therefore, the shares are likely to be traded at $23.50 after the new shares have been issued and absorbed.

TERP Value Fluctuation the During Offering Period

It is possible that many different theoretical values can be estimated during the offering period.  The ultimate value is based on many different possible scenarios and investor sentiment. An investor might look at the TERP value differently if only 25% of the shares are purchased in the rights offering.  Clearly, the expected final value is affected depending on if the issuance is fully absorbed versus 40%, 50%, or 75%. Another consideration is that the more shares purchased, the greater the potential for dilution.  This is because the shares are offered and sold at a discounted offering price.

The theoretical ex-rights price is usually calculated immediately following the last day of a stock’s rights offering. This calculation makes the stock’s price somewhat arbitrary.  As a result, it is potentially more enticing for arbitrage trades throughout the rights offering period. Shareholders can use the TERP to determine the estimated value of the shares after the rights issue. This amount will differ from the current market price.

Throughout the offering period, investors can speculate on the number of shares expected to be taken by shareholders.  However, only current shareholders are allowed to participate. The basis for speculation in this scenario involves the number of share rights available, the expected demand, and the rights offering price. Companies may have various types of disclosure for this information which can make the estimate even more difficult.

Up Next: What Is a Holographic Will?

Holographic WillA holographic will is a document that is handwritten and signed by the person who is writing the will and giving the legacy. Unwitnessed, a holographic will is valid in about half the U.S. states.  However, if properly witnessed, it can be valid in all 50 states.  Ideally, a will should be witnessed according to the laws in your state. Most states require two witnesses.  By signing as witnesses, they confirm that the will was written by the person giving the legacy. Some courts accept holographic wills without witnesses.  However, it can be difficult to prove a will’s validity without witnesses if it is challenged in court.

A holographic will is a handwritten and testator-signed document.  It is an alternative to a will produced by a lawyer. Some states do not recognize holographic wills. States that do permit holographic will require the document to meet specific requirements to be valid. The minimal requirements for most states are proof that the testator wrote the will.  Also, evidence that the testator had the mental capacity to write the will.  Finally, the will must contain the testator’s wish to disburse personal property to beneficiaries.

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