If the expected growth rate in dividend yield increased by 75 points, which of the following would benefit the most, an investor who: A. is short futures contracts on the equity index B. is long futures contracts on the equity index C. Has a long position in put options on equity index
Tricky one. If you haven’t seen it, try and answer it.
I hope I get this A?
There seem to be two things, firstly the current price of the stock increases therefore the future does as well, but PV of dividends is subtracted from the new higher value… I think it isB
B - Increase in dividend yield would essentially bring down the futures price, but since he is already long in the instrument, the investor will benefit from the higher dividend yield + a lock-in on the higher futures price.
Increase in DIV yield would bring down the SPOT. The spot is discounted by the Div yield, the FP discounted by the RFR. Gotta go for B. Not sure though as C - Having put options is essentially shorting (but you dont have unlimited liability) but then again have to pay the premium for the put but hes long with put options so locking in some thing there. Gut feeling is B
If you are already in the contract that means you have already locked in a futures price. So definitely no changes there. An increase in the dividend yield in this case would benefit the short because the spot and expected spot are going to go down. So at the end of the trading day he will bank his profit and will be able to reinvest it. The long put on the index is also in the money but will not have a settlement, so will not be able to reinvest his profit just yet. I go with A What is the answer?
A
jackofalltrades Wrote: ------------------------------------------------------- > B - Increase in dividend yield would essentially > bring down the futures price, but since he is > already long in the instrument, the investor will > benefit from the higher dividend yield + a lock-in > on the higher futures price. I don’t think being long in the futures contract means that the investor is going to benefit from he higher dividend yield. To be long in the futures contract means you’ve locked in a future price to BUY the equity index in the future. So if the futures price is brought down, the long in the future loses. The long in the futures contract definitely isn’t going to benefit from the higher dividend yield because he’s not holding the asset presently. It’s the investor short in the futures contract (A) who wins, profiting from the higher dividend yield and locked into a future price to sell the index which is higher than the spot is going to be in the future (because of the higher dividend yield). One of the Schweser practice tests had a question very similar to this, but the answer was the opposite. In the Schweser test, the wording was something about the rate of dividend growth increasing, implying that “g” was growing, thus the P/E of the index was growing, thus the long future contract wins. The way the question was asked in this thread, it’s just the dividend yield (think “1-b”) that’s growing. Without assuming anything is changing about earnings growth, the growth in dividend yield only affects the present value of future dividend streams, which reduces the value of the long future contract. Answer A.
c
I posted about this last night. This is a BS question and the answer is B. http://www.analystforum.com/phorums/read.php?12,1160709
so what is the asnwer. i will go with A
The answer from the Book is B
so does this mean that what the long actually pays is not the future price agreed on the contract day but sport price of the futures on the payment day.? if that the case then B make sense but if the price the long pays is the locked in price as per gjertsen reasoning then A makes sense. can some one explan which price the long pays at expiration.
AndyPettitteIsGreat - that’s a different question, this is about Index and div yield. I think the answer is A also.
I’d go B as well…
http://www.analystforum.com/phorums/read.php?12,1160709 If you look at the original Schweser practice test question which spawned this thread, they talk about the growth rate in dividends increasing (think “g”). But at the top of this thread, you clearly say dividend YIELD increases (think “1-b”). In the first, g is not only the dividend growth rate, but also the earnings growth rate. In the second, the payout ratio increasing implies nothing about earnings growth. Two very different things. If earnings increase alongside dividends, the equity index grows, and the futures contract price grows. If only the dividend yield increases, then the dividend stream increases, increasing the value to the short of the futures contract.
Yeah, but what’s your take on A vs C. Why A over C?
ro424 - The question that the OP posted is the same exact question I was talking about in my thread…
Common_Sense Wrote: ------------------------------------------------------- > Yeah, but what’s your take on A vs C. Why A over > C? Well, my take is first of all that the question was a misrepresentation of the original Schweser question, so I’m not sure C isn’t a decent answer as well. It’s just more convoluted. And I’m not sure that the equity index isn’t going to go up, so I don’t know that C profits. All I know is that the convenience yield of holding the index is going up, so the futures price is going down.