Effect of cash flows on underlying asset

mehak.officiallink
Good Student
Posts: 31
Joined: Sat Mar 08, 2014 6:59 am

Effect of cash flows on underlying asset

Postby mehak.officiallink » Sun Oct 12, 2014 3:29 pm

If there is a cash flow on underlying asset, why is its present value subtracted from the price of the underlying in finding out the lower bounds ... ?

edupristine
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Joined: Wed Apr 09, 2014 6:28 am

Effect of cash flows on underlying asset

Postby edupristine » Mon Oct 13, 2014 6:27 am

Suppose the underlying asset is a stock on which dividend payments are due in future, then the present value of dividends are subtracted because the value of asset as sown below:

Adjusted intrinsic value would more generally be defined as S0 - PV(X) – PV(D), where D is the dividend to be paid before option expiration.
A high dividend payout policy puts a drag on the rate of growth of the stock price. A higher dividend yield implies a lower expected rate of capital gain. This drag on stock price appreciation decreases the potential payoff from the call option, thereby lowering the call value.


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