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 - - =
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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
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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.
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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
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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: Institutional Background OTC Market ( O ver T he C ounter) The main advantage that the terms of the contract can be tailored to the needs of the traders Customized transactions: Any underlying, any amount, any maturity Fancy combinations available in packages Large Lots Higher trading costs Direct exposure to counterparty risk No clearinghouse Must screen counterparties carefully Organized Exchanges Easy and cheap trading Standardized Maturities Standardized Contract Sizes Limited range of underlying assets--large stocks, heavily traded currencies, etc. Margin requirements for writers Clearinghouse takes on counterparty risk Suppose your broker arranges a trade with your neighbor's broker This results in four separate transactions with corresponding risk exposures: You Your Neighbor Your Broker Your Neighbor's Broker Clearinghouse
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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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