A company announces a rights issue: one new share for every four you hold, at ₹150, when the stock trades at ₹200. A 25% discount, it seems — cheap shares for loyal owners. Then the stock opens lower the next day and the "discount" quietly evaporates. Understanding why is the whole point of the theoretical ex-rights price.
- Existing shares
- shares held before the issue, at the current market price
- New shares
- rights shares taken up, at the discounted rights price
- Total shares
- existing plus new, after the issue
Example: Four shares at ₹200 plus one rights share at ₹150: (4 × 200 + 1 × 150) ÷ 5 = ₹190. The stock should trade near ₹190 ex-rights, not ₹200.
Why the discount is an illusion
A stock at ₹300 announces a 1-for-2 rights at ₹150. What is the theoretical ex-rights price?
Stock ₹200, rights 1-for-4 ₹150 pe — "25% discount" lagta hai. Par agle din price khud gir jaati hai. Theoretical ex-rights price (TERP) = purane aur naye shares ka blended average. (4×200 + 1×150) ÷ 5 = ₹190. ₹50 ka "discount" ₹10 ki price giraawat se cancel — subscribe karo toh na fayda na nuksaan. Value company se aapke paas nahi aati; woh subscribe karne aur na karne walon ke beech shift hoti hai. Sabse mehngi galti: kuch na karna — price ₹190 tak girega par cheap shares bhi nahi milenge = seedha loss. Subscribe karo, ya entitlement bech do — lapse mat hone do.
- TERP is the blended price after a rights issue — old shares and cheap new shares averaged.
- The price falls to TERP mechanically; the drop is arithmetic, not lost value.
- The rights discount is an illusion — it is cancelled by the fall to TERP.
- Subscribe fully and you are value-neutral; skip it and you are diluted.
- If you will not subscribe, sell the entitlement — never let it lapse for nothing.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- what is theoretical ex-rights price
- The theoretical ex-rights price (TERP) is the price a share should trade at right after a rights issue, once the cheap new shares are blended in with the existing ones. It is a weighted average of the old market price and the discounted rights price, weighted by the number of old and new shares. TERP exists because a rights issue mechanically dilutes the price — the drop is arithmetic, not a fall in the company’s value — so TERP is the fair reference point for judging the shares afterwards.
- how to calculate terp
- Multiply the existing shares by the current market price, add the new rights shares multiplied by the rights (discounted) price, and divide by the total number of shares after the issue. For example, holding four shares at ₹200 and buying one rights share at ₹150 gives (4 × 200 + 1 × 150) ÷ 5 = ₹190 — the theoretical ex-rights price. The ₹50 "discount" on the rights share is offset by the ₹10 the price falls from ₹200 to ₹190, so subscribing leaves you no better or worse off.
- does a rights issue dilute existing shareholders
- A rights issue dilutes only shareholders who do not subscribe. If you take up your full entitlement you keep the same proportional stake and are value-neutral, because the cash you put in matches the value the new shares add. If you skip it, your percentage ownership shrinks and the value of your holding falls toward the theoretical ex-rights price without you receiving the offsetting cheap shares — that gap is the real cost of ignoring a rights issue.
- is a rights issue good or bad for shareholders
- It is neither automatically — what matters is why the company is raising money and at what price, not the headline discount. A rights issue to fund a genuinely value-adding project can be good; one to plug a hole in a weak balance sheet is a warning that the business needs cash. The discount itself is an illusion neutralised by the price falling to TERP, so judge the use of the money and the company’s health, and either subscribe or sell your entitlement rather than letting it lapse for nothing.