Acted CM2 paper B online resource: Chap 14: Q3 Discrete Binomial with dividends

Discussion in 'CM2' started by Ijaa254, Sep 24, 2019.

  1. Ijaa254

    Ijaa254 Member

    Hi Acted,
    Again the theory behind this question is not explicitly developed in the core notes.
    The first question asks "Explain why a share price must decrease immediately after a dividend is issued by an amount equal to the dividend payment made".The answer given is to prevent risk free trading/profit. I've googled and it seems it's true that share prices actually drop after dividend payout.
    However, the entire theory for discrete binomial models is developed under the assumption that the stock doesn't pay dividend (see page 3 of chapter 14, section 1.2) and nowhere is this assumption relaxed.
    My main concern is why the Institute/Acted ignores the course notes and sets questions on concepts which they have not developed or even mentioned? Is the drop in share prices after dividend payout part of general public knowledge?
    Shouldn't the insitute or some more sensible third party provide more comprehensive guides if they expect us to know virtually everything about financial engineering and loss reserving?
    I think the Institute/Acted should borrow a leaf from the American company ACTEX publishing especially the study guides prepared by Johnny Li. They cover all topics in detail. I used it for the last chapters part of CM1 and it was a pleasant experience. https://www.actexmadriver.com/samples/ACTEX%20MLC%20Study%20Manual%20Sample.pdf. I passed the overall paper despite failing the horrendous CM1 paper 2 which was set by IFOA.
    Unfortunately I haven't found a guide for financial engineering by Johnny Li.
     
    Last edited by a moderator: Sep 24, 2019
  2. Anna Bishop

    Anna Bishop ActEd Tutor Staff Member

    Hello

    I share your frustration that some ideas seem to have come out of the blue. On the positive side, I'm glad you've seen this as part of your revision and will be prepared for it if it comes up in the exam. Every cloud has a silver lining. :)

    Often the concepts will have been covered somewhere in an earlier subject, for example, the idea of a stock going ex-dividend (and the impact on price) is covered in Subject CM1 (Chapter 13, Page 20). Since CM1 is is a pre-requisite for CM2 then the examiners will assume it's prior knowledge. I've made a note that we should include a binomial model with dividends in our Course Notes, to remind, as you make a valid point.

    Good luck!
    Anna
     
  3. Ijaa254

    Ijaa254 Member

    Thanks. I guess now I have a bit of an idea on how it works especially if you take share price to be the present value of future cashflows. In the answer, they should have given the 'ex-dividend' valuation concept as the reason. The no arbitrage reason is unclear.

    Anyway, I wonder if IFOA is supervised by any examinations regulatory body. I'll follow up on this after the exams especially if the pass rate will still be 30%.
     
    Last edited by a moderator: Sep 24, 2019

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