Q1

Using examples, explain the applications of ‘tracking’ and ‘replication’ in these contexts:

Factor models of asset pricing

An investor wishing to ‘undo’ a firm’s capital structure decision

The binomial option pricing model

Q2

Explain the underlying reasoning for the following propositions in the context of company dividend policy:

‘Dividend policy is irrelevant to a firm’s value’

‘Dividend policy is strongly affected by the tax rates on income and capital gains’

‘Dividend stability and signalling are valued by many investors’

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