Dividend Yield Hull05.03 ( BT Pg 21 of 24)

[notjusttp]

Hi David,

This is a doubt relating to Question 5.03b ( your adds). Its stated that stock pays a dividend of 2% ( as a constant % of stock price) per year. In the solution you have directly taken the rate as 2%. Isn't this an annualised annual rate and aren't we supposed to take continous compounded dividend rate which comes to 1.98 for this.

Though there is hardly any difference to the solution reached in this question however isnt it technically correct to take continous compounded dividend yield when rest of the rates are been continously compounded as there might be differences in answers for a higher dividend yield. Kindly clarify

Thanks and Best Rgds
Amit :roll:

 

[David Harper CFA FRM]

Hi Amit,

Technically, I think the question is okay becase "as a constant % of stock price" implies continuous (following Culp if not necessarily Hull)...
However, I agree with you that it would be more precise (and helpful) to say:
"pays a 2% per annum dividend (with continuous compounding)"

and, if as you suggest, if the question had said
"pays a 2% per annum dividend (with annual compounding)" then either (i) a conversion would be called for, or less likely (out of character for our FRM) (ii) we could "stay" in annual terms:
Forward = $30*(1+12%-2%)^0.5

but nevertheless, your observation is good: you want a continous div yield if we are using Hull's continous cost of carry: forward = spot*EXP(rate+storage-income-convenience)

David