Suppose that the experiment lasts for 15 periods with dividends that are either

Question

Suppose that the experiment lasts for 15 periods with dividends that are either $1 or $3 each with 50 percent probability and with a final redemption value that equals the sum of the dividends realized in the 15 periods. There is no interest paid on cash balances held in each round. Thus the actual final redemption value will depend on the random dividend realizations. Calculate the expected value of the asset at the start of the first period before any dividends have been determined, on average how fast will the expected value of the asset decline in each round? What is the highest amount the final redemption value could be and what is the lowest amount?

Explanation / Answer

Dividend = $1 or $3

Probability = 50%

So Expected dividend value = (1*.50) + (3*.50)

= .50 + .15 = 0.65

Time period taken to be 15 years

Given that final redemption value equals the sum of the dividends realized in the 15 periods.

So, Expected dividend value for 15 years = 0.65*15 = 9.75 $

Present value of asset could not be calculated since discount rate is not given.

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