Question

The dividend yield on a stock option is similar to the foreign interest rate on a foreign currency option.

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True

False

Answer 1

The dividend yield on a stock option is similar to the foreign interest rate on a foreign currency option.

The dividend yielding power of the stock is determined by the Dividend Yield. The calculation of the dividend yield is done based on taking the amount of dividend paid per share during the course of the year and then dividing it by the price of the stock.

Therefore, Dividend Yield = Annual Dividend Payout/Current price of The Stock

If we study deeply, we get to know that the dividend yield will be higher for larger companies. This is because the small companies often retain their earnings in order to expand their business.

On the contrary, a contract that gives the buyer a right to buy or sell a currency but not an obligation to sell at a specified exchange rate on or before the date specified is known as a currency option. In a currency pair, the base currency interest rate is set by the central bank which issues the base currency. This is also known as transaction currency. In Forex markets, the currency are represented in pairs and quoted with relation to other currencies.

Now coming back to the question, the dividend yield on a stock option is similar to the foreign interest rate on a foreign currency option. This statement is not entirely true. This is because in case of stock options, the dividend yield is determined by the company based on its earnings. This Dividend Yield is not fixed and is completely dependent on the amount of earnings that a company has. Furthermore, it is not necessary for the company to declare dividend and it may use it entirely as its retained earnings to finance its other investment opportunities. On the contrary, foreign interest rate on foreign currency is determined by the Central bank of that country. Hence, it is very much regulated as appears because of the involvement of the Central Bank. Hence, if it is said that the currency option is having interest rate, then it has to pay the interest rate. This is not so in case of dividend yield as it may vary based on the profits that the company generates. Hence the statement given above is False.