Theoretical Value (Of a Right)
Candlefocus EditorThe exact calculation for determining the theoretical value of a right varies depending on whether the stock is trading “regular way” or “cum rights”. If a stock is trading regular way, the theoretical value of the right is calculated by subtracting the current market price of the stock from the subscription price. When the stock trades cum rights, the calculation is a bit more complex.
When determining the theoretical value of a right during the cum rights period, investors are generally informed of the price at which they can purchase the shares—usually at a discount to the current market price. They are also told how many rights are necessary to purchase one share of stock. With this information, the theoretical value for each right can be calculated.
The most common way to calculate the theoretical value of a right is by dividing the difference between the market price and the subscription price by the ratio of the rights issue. The difference between the market price and the subscription price is known as the spread or subscription premium. This is then divided by the ratio of the rights issue, which is the number of rights required to purchase one share of stock.
For example, if the stock is trading at $20 per share and the subscription price is $10 per share with a rights ratio of 5, the theoretical value of the right would be calculated as follows: ($20 - $10) / 5 = $2. In other words, each right would be worth $2.
The theoretical value of a right is an important concept for investors to consider when making decisions about their investments. By knowing the theoretical value of the stock, investors can develop informed investment strategies based on their individual goals. Furthermore, the theoretical value of a right provides a quick way to gauge the potential net worth and profitability of the stock.