Suppose the dividend paid on a share takes one of four values, each with equal probability: $0.00, $0.08, $0.28 and $0.60. The share trades for 15 periods. You have chosen to implement a flat fundamental value of $4.80 for this share. This means that you must set the interest rate on cash holdings at:
A) $10%.
B) $25%.
C) $0%.
D) $5%.

Question

Quizplus · Accepted Answer

The expected dividend per period is calculated as the average of the possible dividends: (0.00 + 0.08 + 0.28 + 0.60) / 4 = 0.24. To maintain a flat fundamental value of $4.80, the expected return (dividend yield) must equal the interest rate. Thus, 0.24 / 4.80 = 0.05, or 5%.

Suppose the Dividend Paid on a Share Takes One of Four