Chapter Ten: Derivatives

1. The market price of the stock is $78.50, the intrinsic value of the rights is $1.25 and 3 rights are needed to subscribe for 1 share. What is the subscription price of a right currently trading ex-rights?

$71.25

$73.50

$74.75

$77.25

To answer this question, one must know what the formula is for calculating the intrinsic value when trading ex rights. From the text:

Intrinsic Value = (Market Price – Subscription Price) / number of rights to buy 1 share

Normally, you would be given the Market Price, Subscription Price and number of rights it takes to buy 1 common share. But in this question, you are given everything except the subscription price. So it’s a matter of filling in what you know and solving for what you don’t know:

Intrinsic Value = (Market Price – Subscription Price) / number of rights to buy 1 share

$1.25 = ($78.50 – Subscription Price) / 3

The next step is to isolate the Subscription Price:

$1.25 x 3 = $78.50 – Subscription Price

$3.75 = $78.50 – Subscription Price

Subscription Price = $78.50 - $3.75

Subscription Price = $74.75

Explanation

To answer this question, one must know what the formula is for calculating the intrinsic value when trading ex rights. From the text:

Intrinsic Value = (Market Price – Subscription Price) / number of rights to buy 1 share

Normally, you would be given the Market Price, Subscription Price and number of rights it takes to buy 1 common share. But in this question, you are given everything except the subscription price. So it’s a matter of filling in what you know and solving for what you don’t know:

Intrinsic Value = (Market Price – Subscription Price) / number of rights to buy 1 share

$1.25 = ($78.50 – Subscription Price) / 3

The next step is to isolate the Subscription Price:

$1.25 x 3 = $78.50 – Subscription Price

$3.75 = $78.50 – Subscription Price

Subscription Price = $78.50 - $3.75

Subscription Price = $74.75