Suppose in any period a share dividend takes one of four values: $0.00, $0.08, $0.28 or $0.60 with equal probability. The asset trades for 15 periods and then become valueless. Period 9 has ended and Period 10 has just begun. There are a number of offers to sell that you could consider. Which of the following statements is true?
A) You should not consider buying this share at any price higher than $1.44 unless you are certain to make a speculative gain on the share.
B) You should not consider buying this share at any price lower than $1.44.
C) You should consider buying this share at any price since there are plenty of periods left and you will almost certainly find another trader willing to pay a higher price.
D) You should not consider buying this share regardless of the sale price.

Question

Quizplus · Accepted Answer

Given there are 6 periods left and the dividends can take one of four values ($0.00, $0.08, $0.28, or $0.60) with equal probability, the expected dividend per period is the average of these values: (0 + 0.08 + 0.28 + 0.60) / 4 = $0.24. Over 6 periods, the total expected dividends are 6 * $0.24 = $1.44. Therefore, buying the share for more than $1.44 would not be advisable unless speculative gains are expected, as the expected dividends do not justify a higher price.

Suppose in Any Period a Share Dividend Takes One of Four