Question

1 . Dividend discount model and its problems.

2. Lessons on capital market history. What evidence is there to suggest these lessons are correct?

3. Meaning of Interest -on - Interest ?

4. Different between YTM and RCY ?

5. How Interest-on- Interest affect RCY ?

6. If two bonds have the same duration, then the percentage change in price of the two bonds will be the same for a given change in interest rates . Discuss .

7. Difference between Duration and Time to Maturity?

Answer 1

Answers-

1. Dividend Discount Model-

Meaning- The dividend discount model (DDM) is a quantitative method used for predicting the price of a company's stock based on the theory that it's present day price is worth the sum of all of it's future dividend payments, when discounted back to their present value. It attempts to calculate the fair value of stock irrespective of the prevailing market conditions, and takes into consideration the dividend payout factors and the market expected returns.

Problem-

a) The presumption of a steady and perpetual growth rate less than the cost of capital may not be reasonable.

b)This approach is especially usefull for computing a residual value of future periods.

c) This model is only applicable to mature, stable companies who have a proven track record of paying out dividends consistently.

2. Meaning of Interest-on-interest

Interest on interest is the interest that is earned when interest payments are reinvested. Interest-on-interest is primarily used in the context of bonds which have their coupen payments assumed to be re-invested at some interest rate and held the bond is sold or matured.

Interest-on-interest is also called compound interest.

3.Interest-on-interest affects RCY as

a) Higher interest rates make the cost of holding money in cash costly. People would want to save their money and earn high returns when interest rates are high. However, if the interest rates are low, people wouldn't care much about the returns and would save less and consume more.

b) Moreover, low interest rates implies low borrowing costs and this cheap availability of money would induce people to borrow money from banks and spent on things they are intersted in buying.

c) On the other hand high interest rate implies cost of borrowing money is high which would discourage people to borrow money from banks.

4. Difference between duration and maturity

Sr.No.	DURATION	MATURITY
1.	Duration means length of time	Maturity means the extent to which something is full grown
2	As time passes duration for a bond generally declines	Maturity remains constant irrespective of time.
3