onsider a non-dividend-paying stock with a current price of $50. A 6-month forward contract on the stock is available for purchase. The risk-free interest rate is 4% per annum, compounded continuously. An investor believes that in 6 months, the stock price will either increase by 20% or decrease by 10%. The investor also believes that there is a 60% probability of the stock price increasing and a 40% probability of the stock price decreasin
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Consider a non-dividend-paying stock with a current price of $50. A 6-month
forward contract on the stock is available for purchase. The risk-free interest rate is 4% per
annum, compounded continuously.
An investor believes that in 6 months, the stock price will either increase by 20% or decrease
by 10%. The investor also believes that there is a 60% probability of the stock price increasing
and a 40% probability of the stock price decreasing.
The investor is considering two strategies:
1. Strategy A: Buy the stock today and hold it for 6 months.
2. Strategy B: Buy the 6-month forward contract on the stock.
Part 1: Calculate the forward price of the stock. (i think this = 50*e^(.04*.5)=50e^.02=51.01)
Part 2: Calculate the expected stock price in 6 months and the expected payoff for each strategy.
Part 3: Calculate the minimum amount the investor would be willing to pay for an option that
would allow them to buy the stock in 6 months at the forward price.
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