📚 PASS Research Analyst Certification Examination Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 2.3 — Structure of Securities Market

Imagine you are finalizing your valuation model for a mid-cap manufacturing firm that has just announced a rights issue at a significant discount to the current market price. Your initial impulse might be to view the discounted share price as a bargain for existing shareholders, but as a research analyst, your primary responsibility is to calculate the theoretical ex-rights price (TERP) and evaluate the dilution of Earnings Per Share (EPS).

A rights issue increases the total number of outstanding shares, which exerts downward pressure on the per-share metrics, effectively redistributing the company’s existing value across a broader base of equity.

From a corporate finance perspective, a rights issue is a capital-raising exercise that forces existing shareholders to make a binary choice: either subscribe to their entitlement to maintain their proportionate stake or allow their holdings to be diluted. If the capital raised is deployed into projects with a Return on Invested Capital (ROIC) exceeding the cost of equity, the dilution of EPS is often a temporary phenomenon that yields long-term value accretion.

However, if the firm is raising capital merely to service debt or cover operational inefficiencies, the dilution acts as a permanent erosion of shareholder value.

Consider a case where a company with 100 million shares trading at ₹500 announces a 1-for-4 rights issue at ₹400. To assess the impact, you must calculate the weighted average of the pre-issue market price and the rights issue price. The new share base becomes 125 million, and the market price will mathematically adjust downwards to reflect the increased supply of equity. If your model fails to account for this adjustment, your future projections for ROE and dividend per share will be materially overstated, leading to flawed investment recommendations.

In your research note, you must distinguish between the ’technical dilution’ caused by the increase in the denominator and the ‘fundamental dilution’ that occurs if the new capital fails to earn an adequate return. An analyst who overlooks these mechanics might incorrectly rate a stock as a ‘Buy’ simply because of the discounted price, failing to realize that the market is simply repricing the stock to account for the expanded capital base. Mastering the interplay between TERP, dilution, and capital allocation is essential for providing credible guidance to your clients.1

Nuance

⚠️ Nuance
Candidates often fall into the trap of assuming that a rights issue at a discount is inherently beneficial to the investor because the entry price appears cheap. In reality, the ‘discount’ is merely an accounting adjustment; the market value of the investment does not change simply because new shares are issued at a lower price. An analyst must focus on the firm’s ability to generate incremental returns on the new capital rather than the superficial attractiveness of the issue price.

Check Your Understanding

Practice Question 1

A company with 200,000 outstanding shares trading at ₹1,000 per share announces a 1-for-4 rights issue at ₹800. What is the Theoretical Ex-Rights Price (TERP)?

Practice Question 2

How does a rights issue primarily affect the financial position of a company from an analyst’s perspective?

This is a companion read for Section 2.3 — Structure of Securities Market from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. The Theoretical Ex-Rights Price (TERP) is the market value of the shares after the rights issue is completed, calculated as (Market Cap + Rights Issue Proceeds) / (Total Number of Shares). ↩︎