lecture 19&20

lecture 19&20 - I Lecture 19 ' W19 - - nation date...

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Unformatted text preview: I Lecture 19 ' W19 - - nation date — Derivatives EXP Definition: Option premium — Derivatives are: 0 controversial can fi 0 have led to some huge losses and faiiures (e.g., Procter & Gamble, Orange County, etc.) tip on' ' _gm to b_uy an asset Motivation: Although we will focus on options as financial securities, the concept of options ' at 3“ “exmlse Pl'lce" known iOday applies all over the place: ' on a future matunty date - a student has the option to drop a class if you don’t like the instructor or you think it’s a lousy amide: class ' lntel stock is $59 a a land«oWner has the option to develop a piece of land if the demand for housing goes up ' “all With examisc Price I X: $55 . a factory-owner has the option to close a factory if demand for the product goes down ' exercise the call now = $59 - $55 = $4 a a salesperson often has an option in his contract to get a bonus if his sales are high . ant Intel stock to go up . - onths, do you W I a consumer has a option to return a product for a full refimd if the quality is too low Q: Suppose you own this Call and maturity date 15 three m . you have the Option to many (entry option) or to divorce (exit option) or down? => Call is bet the stock price will 3° uP 1=> our immediate focus is a financial security ' 3:) What We learn applies ‘0 Options found in all types of economic ammgements Q: Ifsimel rises to $62, What 15 the 933mm *9 62—$SS=$7 Q3 Hintel drops to $52, what is the payofi’? OQtions => Ifexercised, $52-$55 = 33-3 If not exercised, $0 Definition: Therefore, best to not exercise. Let T = mattm'ty date 37 = stock price at maturity T Important terms: can payoff: M ST — X , 9 “—*V—’ 1t STSX. if ST>X. mmuucise Exercise (strike) price — the. uterus: : M01031 * A2,0) is theformat‘for a Spread‘he“ b - Recline T. Bliss, Bahson Univest and Terry D. Nixon, Miami Univemil’ FIN 301 A3 a Fall 2011 qu—q—n—mem 172 Buying a call Payoff, + Profit Where if Sr <$55? X: 4545 deg initial Cost of Call=E5 60 Question: How does the payoff change as the stock price increases beyond the exercise price? S]r = Stock Price at Maturity T Stock price Call payoff (to buyer) $56 $1 357 $2 Answer: up dollar—foradollar Call profit = call payoff - initial cost of call Q: Suppose cost of call = $5, where does profit line cross X—axis? A: 1593s; Protit to Buyer 2 Loss to Seller (Writer) Loss “ = Profit “ “ ==> “Zero-Sum Game" Options are “side~bets” [between the buyer and seller} =:> Intel does not gain or lose 9 - Richard T. Bliss. Babson University and Terry D. Nixon, Miami UnivflSItY FIN 301 A,B-Fali 2011 1.” I _'gig to ELI an asset . atan“exercise price” known today I on a future maturity date Ex: I Intci=$59 I put with X=$65 I exerciSe the put now= E32 — $32 =$6 Sci] stock Buy in the lo seller of mice! the pin for ll’IlS for exercise Q2 Suppose that you own the put, do you want Intel to rise or fall? Q: If Intel rises to $66, what is the PaYOff? Pmpayofi=M XeSr, Q MW—A "I if X>Sr "Kn mcmcise then exercise Busiusfl LLeetuie 19 fl '* ‘ Question: How does the payoff change as the stock price decreases below the exercise price? Stock price Put payoff (to buyer) 364 Si $63 $2 Answer: up dollar-for-dollar Q: Does the price of a stock ever fall to $0? ==> Firework company with a single factory location in the desert of Nevada. Blew up! ==> Stock ~‘= S0 Cost of Put 1’ Put Premium = $2 Put profit -= put payoff - $2 Two major types of options: European can exercise at maturity only American -— can exercise before or at maturity Q: Which type would you rather have? > Value of American > Value of European (holding everything else constant) WSJ Option Listing thjgn/Striker 7 55 .70 l,- .. ,l “- [Z‘Lg’Lm ML Maturity date is 3rd Friday of the month. 9 - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University FIN 301 AB-Fafl 2011 176 .. it Which of the above options are valuable if exercised now? Definitions: (note: the below relations are for call options, reverse the So and X for puts) lithe-money. Positive payoff if exercised now- At-the-money. Zero Out-of-the-money. Negative u “- LL it SDHX>0 SD—X=0 So—th . . . . . 9 Q: What patterns do you observe for options With longer times until maturity. . . . . 9 Q- What patterns do you observe for options With greater exemrse prices. W Dividen_d P0._ii|ic Managers should maximize shareholders wealth by maximizing (all else constant) the — Important dates film's common stock price. ‘ HOW Shou'd diVidendS be Paid? 1. Should we retain earnings and invest in new projects to increase stock price, or - Other forms of dividends 2. Should we payout dividends and issue new equity when we need funds. Dividend olic is establish ‘ ' ' ' ' one: p y ed by the Board of Directors and is actually two decrerons In Managing Dividend Payments Board of directors declares a dividend and decides: 1. when it will be paid (typically quarterly), and 2. the $ amount of the dividend. 1. How much of a firm’s earnings should be retained for investment projects, and 2. How much of a firm's earnings should then be distributed as dividends. Earnings available to shareholders = Dividends + Addition to Retained earnings 0 t I. may to the firm nce a dividend is declared it becomes a curren 13 l - Example: $1 £00,000 Earnings available to common shareholders Dividend dates F b 11 M Less c°mm°n diVidendS '39“- 3 Dec. 17 Dec. 21 e - 512001000 Earnings retained M Declaration Ex-dividend Date of ayme . te From this we can calculate the firm’s dividend pay0ut ratio. Date Date Record 03 Dividend payout ratio = S of common divide . ' t Egg-fl— . dwidend, Indlca es ' ' ' . declares the _ S 0f eammgs “Enable *0 common shareholders Dec"375mm date: Day on whichdthetBTJZrzgfciDgfigtfhr: amoun of the divrdend when dividen is o . For our example - ‘ ‘ - , To receive lax-dividend date: The stock no longer trades with entitlementtgzglgfg‘tgsme ex the dividend, investor muSh PUTChase theft; to the dat of record. divmend date' Typically traciulgtfyaay: :mount aPPWXimate'y equal On this date, the stock prices a to the dividend paid. . - reholders eligib'e Date of record: Day on which the company recewes the “St 0f Sha for dividends. _ _ - ' ' Babsan ' i mics-111. Beneath” FIN 301 AB - Fall 2011 ' 4 178- . “N301AB-F$2011 _‘-‘ Lecture 20 Day on which the company distributes dividend checks to shareholders of record. Payment date: Methods of determining dividend Quantity 1. Residual dividend policy - Company only pays dividends when earnings exceed the equity needed for financing investments 3. Estimate $ requirements of planned projects. b. Determine amount of common equity needed to finance projects while maintaining optima! capital structure. . Pay dividend equal to residual earnings (if any). Question: As a shareholder, is this a policy you would favor? Explain- 2- consmnt (%) Payout POHCY ~ Pay dividends as a set percentage of earnings. Year © — Richard T. Bliss, Babson University and Terry D. Nixon, Miami Univcfim’ FIN 301A,B-Fall2011 130 Aconstant dividend policy generally results in too much volatility, therefore, few companies adhere to this policy. 3. Stable Dividends with growth (aka Regular dividend policy) —finns pay conservatively low, sustainable dividends. Dividends are increased only when the new increased ievel can be maintained. Dividends are not reduced because of temporary decreases in earnings. Dividends are decreased only as a last resort. ' but includes an extra ' ' oil 4. Stable ‘ h Extra Dividend —- similar to a stable dwfigisidecr’i‘ “e a”. management Year end dividend in prosperous years. By calling xtr gains flexibility. xtra’ dividend every year or it becomes However mana h Id "0t Pay this He . - , gement s DU I dend. exPia-cued and shareholders view it as a normal dw‘ Reasons for Stock splits and Stock dividends: Other Forms of Dividends i Reduction of stock price — to place the stock’s price in a more affordable range to l 1. Stock DIVIdend — payment of dwldends wrth more common stock rather than cash. attract a wider base of ownership! These are announced in % terms. Eg, You own 100 shares of WWE Enterprises. Vince McMahon announced a 10% ii. Conserve cash, and stock dividend. You receive 100 x .10 = 10 new shares of WWE common stock. .. s..,_.4_ -.AAh-.-m—“a—torua4i.m.m-t—Wm A iii. Signalling ~ signals that management thinks good times are ahead. Question: Why would a company pay a stock dividend? 3. Repurchase of Common Stock — rather than pay 3 deend' the firm n buy bad shares of their own stock. Answer: Question: Why should a firm repurchase its own stock? Answer. . . . _ . . Stock-s price can be 2. Stock Splits 7 very Similar to a stock dividend. The main difference is the proporation > By using cash for repurchases instead of a duffggégzs- of shares paid. Stock splits tend to pay out greater proportions. The stock split is driven upward producing capital gain for the s a usual y given as a ratio. " stock thereby i; The finds managers may decide to issue bonds and repurchase E.g., 2 for 1. 3 for 2. 7 for 5, etc. increasing the firm's financial leverage. Example of a 2—for-1 stock split and 10% stock dividend I 2-for-1 gosh-Th 9f_c£mmon shares 1 "Price Eggs?“ng ' ' ' t. > Stock may be underprioed. It Is a good investmen 3‘ Avoid a hostile corporate raider. 2,000,000 $40.00 $80,000,000 "91110118 of repurchasing: .. . ,, w h a broke“)- !035 stool: dividend _ ug - _.._ A BUY the shares in the secondary make" 0'3" we I: of commonjhares « n'l ' of stOCk 1'100'000 3' Negotiate a purchase with the holder of a large quant'w company. mutual fund, pension fund. 916-} ’Pdseperahace Total shareholder - o u‘ $80,000,000 3- Tender Offer — the comp-Emitr Offers to Shares currently outstanding- : I: 3 a“ m _‘ o _., m 5. m :2 :1 to m :- E (D m o ..., common equity are being cut into more pieces. As . ~ influence overall shareholder wealth. you can see' they do“ necessanly e - Richard T. Bliss, Babson University and Tcny D. Nixon, Miami Univesz FIN 301A,B — Fall 2011 [Lecture 2i___ ' a, : :i,::;:: FongiGN EXCHALJQE - Spot and FonNard Rates - Cross Rates — Hedging - Interest Rate Parity What is an exchange rate? Use ratios to make your life easier. Remember, ratios can be flipped, i.e., they are invariable. Spot and Forward Rates spot transaction forward transaction © - Richard T. Bliss, Babson Unin md Terry D. Nixon, Miami UnivctSIU FIN 301 AB - Fat! 201 1 184 l J i l I 3 mates s We can compute cross rates from the exchange rates we have. Example: Assume a Japanese family wants to Visit Euro-Disney. What currency will ‘ tl'eyneed? Whatisthe appropriate cross rate? “ le” of the Wecan also find cross rates directly in the Key Currency Cross Rates Tab WSJ. - e of the factors Question: How are foreign exchange rates determined? What are 50'“ thatwill influence exchange rates? Partial ants in the Forei n Exchan e FOREX Markets 1- Import‘ers and Exporters 2- investors Arbitrageurs 9T8 W _ T. m gall Tar! [1 “m M 1 F"; 301 5.3 ' F”. m ...
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lecture 19&amp;amp;20 - I Lecture 19 ' W19 - - nation date...

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