Let us discuss today about the dividend yield and its impact on forward prices of commodities:
·
The dividend yield is expressed in percentage
terms. It is ratio or a fraction expressed as the dividend received per share / current trading price of the share.
For example,
·
Assume that a company has issued shares for face
value of $1.00
·
The stock / share is presently trading in the
market for $5.50
·
For the financial year 2012-2013 (April – March),
the company declared a dividend of 50% of face value.
·
In that case, the 50% of face value $1 = $0.50,
is the dividend declared by the company per share.
·
This implies any investor who is holding one
share of the company will be receiving $0.50 as a dividend from the company.
·
The dividend yield in this case is $0.50/$5.50 =
0.0909 or 9.09% (dividend yield in % terms)
·
Now, understand the impact of dividend yield on
commodities or stocks:
·
Dividends are nothing but distribution of
company profits.
·
Had the company not declared dividends, the
dividends would have been in the form of retained earnings in the company
books.
·
This indicates by declaring dividends, the
company indirectly giving a hint, that it is not interested to keep profits as
retained earnings.
·
Let us come back to our discussion.
·
By
distribution of profits to shareholders, in the form of dividends, the book
value of the shares in the company records would come down.
·
Therefore, after declaring the dividends, as the
owner of shares will receive the dividends, but the book value of the shares will
come down.
·
As the book value of a share comes down after
distribution of dividends, the market price of share is also expected to come
down.
·
This
means the dividend yield is expected to reduce the future value of the
commodity.
·
Look at
the following example to understand the impact of dividend yield in commodity
markets:
·
Consider T0
= Current Time
·
T2
= Future time.
·
An investor wants to buy a commodity at T0
from a forward seller at time T2
·
Assume that the present price of the commodity
is $20.00
·
The forward seller would include the following
costs in the forward price at time T0.
·
$1.00 storage costs for the time T0 –
T2
·
$1.50 as the insurance cost for the time T0
– T2
·
$1.50 as the inflation cost for the time T0
– T2
·
The total of all the above comes to: $4.00 for
the time T0 – T2
·
At the same time, the commodity is expected to
pay $0.50 as the dividend to the owner of the commodity between the time T0
– T2.
·
Therefore the total amount to be included in the
forward price is:
·
$4.00
(expenses) - $0.50 (dividend income on commodity) = $3.50 as the net
cost for the forward seller for holding the commodity for the time T0
– T2
·
Therefore the seller will keep the forward price
to sell at $23.50
·
In this example, the time value of money is not
considered.
·
Therefore
please understand that is why the dividend yield is reduced from the formula
used for calculating the forward price of the commodity.
·
Therefore
expected future price of the stock = S0e(r – δ).
