Understanding Put-Call Parity and Derivatives Markets
Put–Call Parity
This model states that for a given call price, the corresponding put price for the same exercise price and tenure can be determined. This is known as the Put–Call Parity rule.
Consider two portfolios:
- First Portfolio: Stock + Put
- Second Portfolio: Call + Present Value of Strike Price
At expiry, the value of both portfolios will be equal under all conditions.
Analysis at Expiry
Case 1: Stock Price < Exercise Price (e.g., 80 < 100)
- Portfolio A (Stock + Put): Stock price at end +
Financial Valuation Methods: DDM, P/E, and DCF Analysis
Two-Stage Dividend Discount Model (DDM)
PQW will pay an annual dividend of 0.65 one year from now. Analysts expect this dividend to grow at 12% per year until the fifth year. After the fifth year, the growth rate will be 2% per year forever. If the firm’s equity cost of capital is 8%, what is the value of a share of PQW stock using the dividend discount model?
Given Data
- D1 = 0.65
- g1 (Years 1–5) = 12%
- g2 (after Year 5) = 2%
- r = 8%
Step 1: Calculate Dividends for Years 1–5
- D1 = 0.65
- D2 = 0.65(1.12)
Capital Structure, Project Cash Flows, WACC and IRR
Capital Structure (Ch 16)
Capital structure = mix of debt and equity.
Unlevered = no debt.
Levered = some debt.
Financial leverage = fixed interest that magnifies EPS.
Debt is cheaper because interest is tax deductible.
Companies avoid all debt because too much raises bankruptcy risk.
When debt helps shareholders
Return on assets > cost of debt.
EPS after borrowing > EPS before.
When debt hurts shareholders
Return on assets < cost of debt.
EPS decreases.
Break-Even EBIT (BEEBIT)
BEEBIT graph: break-even
Read MoreInvestment Assets: Mutual Funds, Equity, and Risk
Types of Mutual Funds
Open-Ended Schemes
In this scheme, there is an uninterrupted entry and exit into the funds. The open-ended scheme has no maturity period, and they are not listed on the stock exchanges. The open-ended fund provides liquidity to the investors since repurchase is available.
Closed-Ended Funds
The closed-ended funds have a fixed maturity period. The first-time investments are made when the closed-ended scheme is kept open for a limited period. Once closed, the units are listed on
Read MoreWACC, NPV, IRR, Cost of Equity & Capital Structure Formulas
1. Cost of Equity (Dividend Growth Model)
Use when given the last dividend, growth rate, and price
Steps
Find next year’s dividend
Next dividend = Last dividend × (1 + growth rate)
Cost of equity = (Next dividend ÷ Stock price) + Growth rate
Excel
=(D0*(1+g)/Price) + g
2. Cost of Debt (Yield to Maturity)
Your system almost always uses annual coupons, even if the bond states semiannual.
Steps
Coupon payment = Coupon rate × Par value.
Discount each payment using a trial interest rate until the present value
Portfolio Management: Markowitz, CAPM, CML, APT & Returns
Key Topics
- Portfolio Management – Concept and Markowitz Model
- Portfolio Selection – Capital Market Line, Security Market Line, Capital Asset Pricing Model and Arbitrage Pricing Theory
- Portfolio Performance Evaluation – Sharpe, Treynor and Jensen Models
To provide a helpful overview, I can explain the core concepts of each section.
💰 Portfolio Management Concepts
Portfolio Management and Markowitz Model
- Portfolio Management: The art and science of making decisions about investment mix and policy,