Question

What can you say about the value of stock with constant dividend growth where the growth rate is larger than the discount rate?

In the dividend discount model, the stock price increases at the rate of dividend growth (g), and g=ROE*b. Why or why not is it always in the best interest of shareholders if a company decides to reinvest a larger portion of its net income (increasing b)? Assume constant and positive ROE.

What are similarities between buying stocks on margin and buying call options for that stock? (Name any two)

How can a business use future for risk management?

How can an investor use derivative for risk management?

Answer 1

You have asked multiple unrelated questions in the same post. I will address the first one. Please post the balance questions one by one separately.

What can you say about the value of stock with constant dividend growth where the growth rate is larger than the discount rate?

Such a stock will achieve a value which will be more than the value of the GDP / size of the country. Theoretically such a stock doesn't exist. This is because:

• A stock can temporarily grow at a rate higher than the discount rate but not in perpetuity.
• Such a stock will have a negative terminal value.
• Such a stock will have abnormal return, which will lead to massive arbitrage and all the capital in the world will be chasing this stock.

Hence, such a stock doesn't exist. And if it does exist, it will have an abnormally high value and will soon reach a level where its value will greater than the size of the GDP itself.