In the formula : FP= S0 x e (Rc - dc)t
Why are we using continuously compounded risk-free rate and dividend yield? I was thinking that by simply using e in the formula, we are assuming continuous compounding. Any explanations please?
The S&P 500 has roughly 500 stocks, about 80% of which pay dividends. That’s 1,600 dividends per year (assuming that they’re all paid quarterly) that you’d have to discount back to today.
It’s much easier to assume that they’re paid continually. You’ll be off a little bit, but not too much.
And as long as we’re using a continuous dividend rate, we might as well use a continuous risk-free rate to make the formulae simpler.
That’s the rationale.
Continuous componding is represented by e to the power of interest rate. Your question is weird. Do you mean why we deduct dividend yield?
Most easiest way to compare the yield - this is the benefit of the continuously compounded risk-free rate and dividend yield.
If you have 2 share one is paying 12 times dividend other is 1 times it will be difficult to see the true different without calculation.