TERP and Trading Nil-Paid Rights

A company that wants to raise cash without borrowing can offer existing shareholders the chance to buy new shares directly from it, usually at a discount to the market price. This is a rights issue. Because the new shares are cheaper than the old ones, and there are now more shares outstanding, the stock's "fair" price after the issue has to sit somewhere between the old market price and the subscription price. That blended price is the theoretical ex-rights price, or TERP — the price the stock should trade at once the rights issue has diluted the share count.

Working out TERP

Say a stock trades at $10 before the announcement, and the company offers one new share at $6 for every four shares already held. After the issue, someone who held four old shares now effectively holds five shares, having paid $6 for the fifth. TERP blends those: four shares worth $10 plus one share worth $6, divided by five shares in total, works out to $9.20. That $9.20 is the reference price the market uses once the stock goes "ex-rights" — existing holders are no worse off in total value, but each individual share is worth less than it was, exactly offsetting the cheap new shares they're entitled to buy.

The right itself trades separately

Between the announcement and the day new shares are issued, the entitlement to buy at $6 becomes a tradeable instrument in its own right, called a nil-paid right (nothing has been paid for it yet — it's purely the right to subscribe). It trades on the exchange alongside the stock. Its value tracks the gap between TERP and the subscription price: in the example above, a nil-paid right should be worth roughly $9.20 − $6 = $3.20, because that's exactly what a holder saves by buying through the right instead of at the market price.

This matters to anyone holding the stock going into a rights issue. There are three choices: subscribe for the new shares (pay $6 per right and end up with more stock), sell the nil-paid rights on the market and pocket the cash, or do nothing — in which case the rights typically expire worthless and the shareholder is left diluted with no compensation. Underwriters exist precisely to buy up any unsold rights so the company still raises the cash it needs even if some shareholders let their entitlement lapse.

What this means in practice

Anyone pricing or hedging a stock through a rights issue needs to use TERP, not the pre-announcement price, once the ex-rights date passes — index providers and data vendors apply an adjustment factor for exactly this reason, the same way they do for ordinary dividends and splits. A trader long the stock going into the record date effectively also holds a short-dated, decaying option-like instrument (the nil-paid right) that needs its own decision before expiry.