FINRA Series 7Investment Information and Suitable RecommendationsMedium
XYZ stock is trading at $53 per share cum rights. The subscription price for a rights offering is $48, and 4 rights plus the subscription price are required to purchase one new share. What is the theoretical value of one right?
- A$0.80
- B$1.00
- C$5.00
- D$1.25
Show answer & explanationAnswer & explanation
Correct answer: B. $1.00
Cum-rights formula: Value = (Market price − Subscription price) / (N + 1), where N is the number of rights needed. Value = ($53 − $48) / (4 + 1) = $5 / 5 = $1.00.
Why the other options are wrong
- A. Incorrect — results from dividing by N instead of N+1 incorrectly or miscalculating the spread.
- C. Incorrect — this is just the price differential without dividing by (N+1).
- D. Incorrect — this would result from an incorrect denominator of 4.
Theoretical Value of a Right (Cum-Rights)
The calculated value of a subscription right while the stock still trades with rights attached, found by dividing the market/subscription price spread by (N+1).
- Cum-rights formula: (Market − Subscription)/(N+1)
- Ex-rights formula: (Market − Subscription)/N
- N = number of rights needed to buy one new share
Memory trick: Cum-rights: add 1 to N because stock still carries the right.