Dividend Discount Model
Financial Market Revision
Question 1 Performance Evaluation Calculation Discursive 20% 80% Question 2 Dividend Valuation Model 45% 55% Question 3 Option strategies Straddles 80% 20% Question 4 Duration and convexity –Price – yield relationship 30% 70% Question 5 Option and Futures -mixed N/A 100% Question 6 CAPM 40% 60%
Dividend Discount Models 1. The intrinsic value, denoted V0, of a share of stock is defined as the present value of all cash payments to the investor in the stock, including dividends as well as the proceeds from the ultimate sale of the stock, discounted at the appropriate risk-adjusted interest rate, k. Whenever the intrinsic value, or the investor’s own estimate of what the stock is really worth, exceeds the market price, the stock is considered undervalued and a good investment. 2. Dividend Discount Model: Stock valuation model that solves for the value of a common stock as the present value of future dividends expected to be received. 3. The dividend discount model holds that the price of a share of stock should equal the present value of all future dividends per share, discounted at an interest rate commensurate with the risk of the stock. 4. The constant growth dividend discount model is best suited for firms that are expected to exhibit stable growth rates over the foreseeable future. In reality, however, firms progress through lifecycles. In early years, attractive investment opportunities are ample and the firm responds with high plowback ratios and rapid dividend growth. Eventually, however, growth rates level off to more sustainable values. Threestage growth models are well-suited to such a pattern. These models allow for an initial period of rapid growth, a final period of steady dividend growth, and a middle, or transition, period in which the dividend growth rate declines from its initial high rate to the lower sustainable rate. 5. Problems of dividend-based valuations: investors tend to have very different expectations from
Question 1 Performance Evaluation Calculation Discursive 20% 80% Question 2 Dividend Valuation Model 45% 55% Question 3 Option strategies Straddles 80% 20% Question 4 Duration and convexity –Price – yield relationship 30% 70% Question 5 Option and Futures -mixed N/A 100% Question 6 CAPM 40% 60%
Dividend Discount Models 1. The intrinsic value, denoted V0, of a share of stock is defined as the present value of all cash payments to the investor in the stock, including dividends as well as the proceeds from the ultimate sale of the stock, discounted at the appropriate risk-adjusted interest rate, k. Whenever the intrinsic value, or the investor’s own estimate of what the stock is really worth, exceeds the market price, the stock is considered undervalued and a good investment. 2. Dividend Discount Model: Stock valuation model that solves for the value of a common stock as the present value of future dividends expected to be received. 3. The dividend discount model holds that the price of a share of stock should equal the present value of all future dividends per share, discounted at an interest rate commensurate with the risk of the stock. 4. The constant growth dividend discount model is best suited for firms that are expected to exhibit stable growth rates over the foreseeable future. In reality, however, firms progress through lifecycles. In early years, attractive investment opportunities are ample and the firm responds with high plowback ratios and rapid dividend growth. Eventually, however, growth rates level off to more sustainable values. Threestage growth models are well-suited to such a pattern. These models allow for an initial period of rapid growth, a final period of steady dividend growth, and a middle, or transition, period in which the dividend growth rate declines from its initial high rate to the lower sustainable rate. 5. Problems of dividend-based valuations: investors tend to have very different expectations from