Definitions of Rights issues, Options and Warrants
A rights issue is where a company offers existing shareholders a chance to buy new shares in the company at below market rates at a future date.
They’re usually offered to shareholders in proportion to their existing shareholdings.
Options and warrants are similar in the sense that people, often employees can get the opportunity to buy shares at below their market rate.
What is a Bonus Element?
Because rights issues are usually at less than full market price they include a bonus element.
These bonus elements are to encourage the shareholders to take up their entitlement.
Since there is a bonus element in the issue price, we must adjust the EPS calculation for comparative years, to ensure a fair comparison of the current year EPS with any previous period’s EPS.
The reason behind this is that the bonus element will result is more shares being issued to raise money than would have been if the shares were issued at full market price.
Rights Issue Adjustment
To adjust the EPS comparison, we multiply the prior years’ EPS by the market price (fair value) of the share before the rights issue and divide it by the theoretical ex rights price.
Theoretical Ex-Rights Price (TERP)
The theoretical ex-rights price (also known as TERP) is the price that the shares should be, in theory, after the rights issue.
It is a weighted average price of the shares before the rights issue and the new shares in the rights issue.
To work this out:
- take the number of shares needed to get the rights issue (you might be allowed one rights issue for every five shares you own, so take the five shares),
- multiply them by the market price before the rights issue,
- then add the rights issue share and how much it’ll cost,
- divide all of this by the number of shares you’ll own after the rights issue.