The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.
###P_0=\frac{d_1}{r-g}###
A stock pays dividends annually. It just paid a dividend, but the next dividend (##d_1##) will be paid in one year.
According to the DDM, what is the correct formula for the expected price of the stock in 2.5 years?
Which of the following statements about the weighted average cost of capital (WACC) is NOT correct?
There are many different ways to value a firm's assets. Which of the following will NOT give the correct market value of a levered firm's assets ##(V_L)##? Assume that:
- The firm is financed by listed common stock and vanilla annual fixed coupon bonds, which are both traded in a liquid market.
- The bonds' yield is equal to the coupon rate, so the bonds are issued at par. The yield curve is flat and yields are not expected to change. When bonds mature they will be rolled over by issuing the same number of new bonds with the same expected yield and coupon rate, and so on forever.
- Tax rates on the dividends and capital gains received by investors are equal, and capital gains tax is paid every year, even on unrealised gains regardless of when the asset is sold.
- There is no re-investment of the firm's cash back into the business. All of the firm's excess cash flow is paid out as dividends so real growth is zero.
- The firm operates in a mature industry with zero real growth.
- All cash flows and rates in the below equations are real (not nominal) and are expected to be stable forever. Therefore the perpetuity equation with no growth is suitable for valuation.
Where:
###r_\text{WACC before tax} = r_D.\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital before tax}### ###r_\text{WACC after tax} = r_D.(1-t_c).\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital after tax}### ###NI_L=(Rev-COGS-FC-Depr-\mathbf{IntExp}).(1-t_c) = \text{Net Income Levered}### ###CFFA_L=NI_L+Depr-CapEx - \varDelta NWC+\mathbf{IntExp} = \text{Cash Flow From Assets Levered}### ###NI_U=(Rev-COGS-FC-Depr).(1-t_c) = \text{Net Income Unlevered}### ###CFFA_U=NI_U+Depr-CapEx - \varDelta NWC= \text{Cash Flow From Assets Unlevered}###Question 432 option, option intrinsic value, no explanation
An American style call option with a strike price of ##K## dollars will mature in ##T## years. The underlying asset has a price of ##S## dollars.
What is an expression for the current intrinsic value in dollars from owning (being long) the American style call option? Note that the intrinsic value of an option does not subtract the premium paid to buy the option.
Question 538 bond pricing, income and capital returns, no explanation
Risk-free government bonds that have coupon rates greater than their yields:
A trader buys one crude oil European style call option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of $6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the:
Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?
Question 708 continuously compounding rate, continuously compounding rate conversion
Convert a 10% continuously compounded annual rate ##(r_\text{cc annual})## into an effective annual rate ##(r_\text{eff annual})##. The equivalent effective annual rate is:
Question 793 option, hedging, delta hedging, gamma hedging, gamma, Black-Scholes-Merton option pricing
A bank buys 1000 European put options on a $10 non-dividend paying stock at a strike of $12. The bank wishes to hedge this exposure. The bank can trade the underlying stocks and European call options with a strike price of 7 on the same stock with the same maturity. Details of the call and put options are given in the table below. Each call and put option is on a single stock.
European Options on a Non-dividend Paying Stock | |||
Description | Symbol | Put Values | Call Values |
Spot price ($) | ##S_0## | 10 | 10 |
Strike price ($) | ##K_T## | 12 | 7 |
Risk free cont. comp. rate (pa) | ##r## | 0.05 | 0.05 |
Standard deviation of the stock's cont. comp. returns (pa) | ##\sigma## | 0.4 | 0.4 |
Option maturity (years) | ##T## | 1 | 1 |
Option price ($) | ##p_0## or ##c_0## | 2.495350486 | 3.601466138 |
##N[d_1]## | ##\partial c/\partial S## | 0.888138405 | |
##N[d_2]## | ##N[d_2]## | 0.792946442 | |
##-N[-d_1]## | ##\partial p/\partial S## | -0.552034778 | |
##N[-d_2]## | ##N[-d_2]## | 0.207053558 | |
Gamma | ##\Gamma = \partial^2 c/\partial S^2## or ##\partial^2 p/\partial S^2## | 0.098885989 | 0.047577422 |
Theta | ##\Theta = \partial c/\partial T## or ##\partial p/\partial T## | 0.348152078 | 0.672379961 |
Which of the following statements is NOT correct?
Question 905 market capitalisation of equity, PE ratio, payout ratio
The below graph shows the computer software company Microsoft's stock price (MSFT) at the market close on the NASDAQ on Friday 1 June 2018.
Based on the screenshot above, which of the following statements about MSFT is NOT correct? MSFT's: