Lecture_20-spring

# Lecture_20-spring - Lecture 20 Options Markets Dividend...

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Lecture 20 Options Markets

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Dividend Discount Model 1. Simplest Dividend Discount Model 2. 3. P 0 = Value of Assets in Place + Present Value of Growth Opportunities P 0 = E 1 /k + PVGO 4. 5 + = k E PVGO k E P / 1 1 1 1 0 b ROE k b E g k D P * ) 1 ( 1 1 0 - - = - = g k D P - = 1 0 b ROE k b E P * ) 1 ( 1 0 - - =
High Tech Chip Company paid a dividend last year of \$2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be A) \$1.00 B) \$2.50 C) \$2.69 D) \$2.81 E) none of the above

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Answer: C Rationale: g = .125 X .6 = 7.5%; \$2.50(1.075) = \$2.69
Low Fly Airline is expected to pay a dividend of \$7 in the coming year. Dividends are expected to grow at the rate of 15% per year. The risk-free rate of return is 6% and the expected return on the market portfolio is 14%. The stock of low Fly Airline has a beta of 3.00. The intrinsic value of the stock is ______. A) \$46.67 B) \$50.00 C) \$56.00 D) \$62.50 E) none of the above

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Answer: A Rationale: k=6% + 3(14% - 6%) = 30%; V 0 =D 1 /(k-g)= 7 / (.30 - .15) = \$46.67.
Options Markets

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Options Definition An option is a contract that gives the buyer the right, (not the obligation) to buy or sell an underlying asset at a specific price on or before a certain date. 8
Types of Options European vs American Options European: Owner can only exercise on maturity date American Options: Owner can exercise on or before maturity date Call vs. Put Call option - gives the holder the option to purchase an underlying asset for a strike price on or before specified expiration date Put option -gives the holder the option to sell an underlying asset for a strike price on or before specified expiration date

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Options on different assets Options are written on different underlying assets. Some examples include Single stocks Stock Indexes (S&P500) Foreign Currency Interest rates

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Call Options A call option gives the buyer the right to purchase an asset at a certain price within a specific period of time.
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## This note was uploaded on 04/17/2008 for the course ECON 171A taught by Professor Yusim during the Spring '08 term at Brandeis.

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Lecture_20-spring - Lecture 20 Options Markets Dividend...

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