1 / 16

Chapter 7

Chapter 7. Options and Corporate Finance. Shapiro and Balbirer: Modern Corporate Finance: A Multidisciplinary Approach to Value Creation Graphics by Peeradej Supmonchai. Learning Objectives. Explain the distinction between different types of options.

kamal-wiggins
Download Presentation

Chapter 7

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 7 Options and Corporate Finance Shapiro and Balbirer: Modern Corporate Finance: A Multidisciplinary Approach to Value Creation Graphics by Peeradej Supmonchai

  2. Learning Objectives • Explain the distinction between different types of options. • Identify the factors that influence an option’s value and describe how changes in these factors can influence the value of an option. • Indicate how options may be embedded in investment decisions and why management flexibility may be considered an option. • Describe the ways in which a company’s common stock and a call option are similar. • Indicate how option pricing theory can help us understand complex securities like convertible debt. • Use option pricing theory to describe the agency’s conflicts between stockholders and creditors.

  3. Option Terminology • Option is the right, but not the obligation, to buy or sell any asset at a set price at some future date. • Right to buy is a call option • Right to sell is a put option • Premium - Amount paid for the option privilege • Exercise, or Strike Price - Price at which the option can be exercised • Long - a position in which one has bought options • Short - a position in which one has sold options

  4. Option Terminology (Cont.) • Profit if exercised at current price • In-the-money option • At-the-money option • Out-of-the-money option • Exercise timing • European option • American option

  5. Payoffs From a European Call Option Payoff 25 28 40 Call Premium of $3 Stock Price

  6. Mathematical Representation of a European Call Option Where: C = the value of call options max = the maximum of (S-X) and 0 S = the selling price of underlining assets X = the exercise price of options

  7. Payoff From a European Put Option Payoff 23 25 40 Put Premium of $2 Stock Price

  8. Mathematical Representation of a European Put Option Where: P = the value of put options max = the maximum of (X-S) and 0 S = the selling price of underlining assets X = the exercise price of options

  9. Black-Scholes Option Pricing Model Where: C(t) = the value of a call option t = the time until the option expires S = the current price of the stock X = the exercise ( or strike) price of the option r = the continuously compounded risk-free rate of interest N(d) = the value of a probability density function in which the probability of a normally-distributed random variable taking on a value is less than d.

  10. Call Option Valuation VARIABLE INCREASES OPTION VALUE Stock Price Volatility Increases Time to Expiration Increases Exercise Price Decreases Current Stock Price Increases Risk-Free Interest Rate Increases

  11. Option Values and Stock Prices for Various Expiration Times Option Value 10 years Y 5 years Z 1 year 45° X Stock Price(s)

  12. Option Valuation and Investment Decisions • Potential Plant Expansion • R&D as an option • Project Abandonment

  13. Common Stock as a Call Option -An Example Suppose that Greene Products has borrowed $2 million that must be repaid next year. At this time, Greene’s owners must decide whether to repay the debt. How would they make that decision?

  14. Payoffs to Greene’s Stockholders Payoffs toStockholders 45º 0 $2,000 Market Value of the Firm’s Asset

  15. Payoffs to Greene’s Bondholders Payoffs to Stockholders Market Value of the Firm’s Asset

  16. Solutions to Agency Problems - Insights From Option Pricing Theory • Stockholder - Creditor Conflicts • Covenants in Bond Contracts • Use of Convertible Debt • Owner - Manager Conflicts • Use of Stock Options

More Related