The correct answer and explanation is:
The correct answer is: cash payout received by selling shares to receive current cash or purchasing additional shares to reduce current cash
Homemade dividends are a concept from financial theory, most notably the Modigliani-Miller dividend irrelevance proposition. The theory states that a company’s dividend policy does not affect its value in a perfect market with no taxes or transaction costs. The reasoning behind this is that investors are not dependent on the company’s decisions to create their desired cash flow.
The concept of homemade dividends describes the ability of a stockholder to create a personalized cash flow stream from their investment. They can effectively change the net cash payout they receive from their holdings, regardless of the official dividend paid by the corporation.
There are two primary ways an investor can do this. First, if a company pays a small dividend or no dividend at all, an investor who needs current income can sell a small portion of their stock holdings. The cash received from this sale acts as a “homemade” or synthetic dividend.
Conversely, if a company pays a larger dividend than the shareholder desires, the shareholder can take the cash received from that dividend and use it to purchase additional shares of the same company. This action effectively cancels out the cash payout and reinvests the money back into the firm, just as if the company had retained the earnings in the first place.
Therefore, this mechanism allows a stockholder to customize their cash payout by selling shares to generate cash or using received dividends to buy more shares, perfectly aligning with the description in the correct answer. The other options are incorrect because an individual stockholder cannot alter the dividend paid by the issuer or single-handedly increase the market value of a share.
