Suppose the price of gasoline per gallon is currently $5. The risk manager of Universe Airlines expects the price per gallon next year to be either $7 or $4 with equal probabilities. The company plans to buy 1 million gallons of gasoline in one year. The risk manager is concerned about future rising cost of gasoline and is considering using either futures or calls to hedge against the risk. Suppose the riskfree interest rate is 10% per annum. What is the futures price of gasoline per gallon for delivery in one year? What are the possible payoffs of the futures one year from now? If calls are used, only the ones with the same exercise price as the futures price are available now. How much would it cost to buy the calls? What are the possible profits of the calls (the payoffs net of the call premium) one year from now? Suppose the investors of the company are risk averse and their collective risk attitude can be described by log utility. Assume that the risk manager maximizes the expected utility of the company which is worth $20 million right now. Which hedging method is better, the futures or the calls?
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
Suppose the price of gasoline per gallon is currently $5. The risk manager of Universe Airlines expects the price per gallon next year to be either $7 or $4 with equal probabilities. The company plans to buy 1 million gallons of gasoline in one year. The risk manager is concerned about future rising cost of gasoline and is considering using either futures or calls to hedge against the risk. Suppose the riskfree interest rate is 10% per annum.
- What is the futures price of gasoline per gallon for delivery in one year? What are the possible payoffs of the futures one year from now?
- If calls are used, only the ones with the same exercise price as the futures price are available now. How much would it cost to buy the calls? What are the possible profits of the calls (the payoffs net of the call premium) one year from now?
- Suppose the investors of the company are risk averse and their collective risk attitude can be described by log utility. Assume that the risk manager maximizes the expected utility of the company which is worth $20 million right now. Which hedging method is better, the futures or the calls?
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