The following equation is called the Dividend Discount Model (DDM), Gordon Growth Model or the perpetuity with growth formula: ### P_0 = \frac{ C_1 }{ r - g } ###
What is ##g##? The value ##g## is the long term expected:
On his 20th birthday, a man makes a resolution. He will deposit $30 into a bank account at the end of every month starting from now, which is the start of the month. So the first payment will be in one month. He will write in his will that when he dies the money in the account should be given to charity.
The bank account pays interest at 6% pa compounding monthly, which is not expected to change.
If the man lives for another 60 years, how much money will be in the bank account if he dies just after making his last (720th) payment?
You own a nice suit which you wear once per week on nights out. You bought it one year ago for $600. In your experience, suits used once per week last for 6 years. So you expect yours to last for another 5 years.
Your younger brother said that retro is back in style so he wants to wants to borrow your suit once a week when he goes out. With the increased use, your suit will only last for another 4 years rather than 5.
What is the present value of the cost of letting your brother use your current suit for the next 4 years?
Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new suit when your current one wears out and your brother will not use the new one; your brother will only use your current suit so he will only use it for the next four years; and the price of a new suit never changes.
Question 385 Merton model of corporate debt, real option, option
A risky firm will last for one period only (t=0 to 1), then it will be liquidated. So it's assets will be sold and the debt holders and equity holders will be paid out in that order. The firm has the following quantities:
##V## = Market value of assets.
##E## = Market value of (levered) equity.
##D## = Market value of zero coupon bonds.
##F_1## = Total face value of zero coupon bonds which is promised to be paid in one year.
The levered equity graph above contains bold labels a to e. Which of the following statements about those labels is NOT correct?
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.
A company advertises an investment costing $1,000 which they say is underpriced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Assume that there are no dividend payments so the entire 15% total return is all capital return.
Assuming that the company's statements are correct, what is the NPV of buying the investment if the 15% return lasts for the next 100 years (t=0 to 100), then reverts to 10% pa after that time? Also, what is the NPV of the investment if the 15% return lasts forever?
In both cases, assume that the required return of 10% remains constant. All returns are given as effective annual rates.
The answer choices below are given in the same order (15% for 100 years, and 15% forever):
Question 522 income and capital returns, real and nominal returns and cash flows, inflation, real estate
A residential investment property has an expected nominal total return of 6% pa and nominal capital return of 2.5% pa. Inflation is expected to be 2.5% pa.
All of the above are effective nominal rates and investors believe that they will stay the same in perpetuity.
What are the property's expected real total, capital and income returns?
The answer choices below are given in the same order.
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?
The symbol ##\text{GDR}_{0\rightarrow 1}## represents a stock's gross discrete return per annum over the first year. ##\text{GDR}_{0\rightarrow 1} = P_1/P_0##. The subscript indicates the time period that the return is mentioned over. So for example, ##\text{AAGDR}_{1 \rightarrow 3}## is the arithmetic average GDR measured over the two year period from years 1 to 3, but it is expressed as a per annum rate.
Which of the below statements about the arithmetic and geometric average GDR is NOT correct?
On 1 February 2016 you were told that your refinery company will need to purchase oil on 1 July 2016. You were afraid of the oil price rising between now and then so you bought some August 2016 futures contracts on 1 February 2016 to hedge against changes in the oil price. On 1 February 2016 the oil price was $40 and the August 2016 futures price was $43.
It's now 1 July 2016 and oil price is $45 and the August 2016 futures price is $46. You bought the spot oil and closed out your futures position on 1 July 2016.
What was the effective price paid for the oil, taking into account basis risk? All spot and futures oil prices quoted above and below are per barrel.