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Cp. 8: Financial Options and Applications in Corporate Finance

The document discusses financial options and applications in corporate finance. It defines a put option as an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame. The opposite is a call option. The document also discusses how put options can be valued using the Black-Scholes formula, and outlines four major areas where option pricing is used in corporate finance: real options analysis for project evaluation and strategic decisions, risk management, capital structure decisions, and financial risk management.

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81 views12 pages

Cp. 8: Financial Options and Applications in Corporate Finance

The document discusses financial options and applications in corporate finance. It defines a put option as an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame. The opposite is a call option. The document also discusses how put options can be valued using the Black-Scholes formula, and outlines four major areas where option pricing is used in corporate finance: real options analysis for project evaluation and strategic decisions, risk management, capital structure decisions, and financial risk management.

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esthd
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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C P.

8 : F I N A N C I A L O P T I O N S
A N D A P P L I C AT I O N S I N
C O R P O R AT E F I N A N C E

BY:
LAURA LENGKEY 17061103035
RICHRDO HONGJOYO 17061103043
ANDRE LENGKEY 17061103051
ESTHER MALONDA 17061103059
8.6 THE VALUATION OF PUT OPTIONS
WHAT IS A PUT OPTION?

It is an option contract giving the owner the right, but not the obligations, to
sell a specified amount of an underlying security at a specified price within a
specified time frame.

This is the opposite of a call option, which gives the holder the right to buy an
underlying security at a specified price, before the option expires.
• A put option gives its owner the right to sell a share of stock. Rather than reinventing the
wheel, consider the payoffs for two portfolios at expiration date T. The first portfolio
consists of a put option and a share of stock, the second has a call option (with the same
strike price and expiration date as the put option) and some cash. The amount of cash is
equal to the present value of the exercise cost discounted at the continuously compounded
risk-free rate. At expiration, the value of this cash will equal the exercise cost, X
• If PT, the stock price at expiration date T, is less than X, the strike price when the option
expires, then the value of the put option at expiration is X − PT. Therefore, the value of
Portfolio 1, which contains the put and the stock, is equal to X minus PT plus PT, or just X.
For Portfolio 2, the value of the call is zero at expiration (because the call option is out-of-
the-money), and the value of the cash is X, for a total value of X. Notice that both portfolios
have the same payoffs if the stock price is less than the strike price.
• The stock price is greater than the strike price at expiration.
• In this case, the put is worth nothing, so the payoff of Portfolio 1 is equal to
PT, the stock price at expiration. The call option is worth PT − X, and the
cash is worth X, so the payoff of Portfolio 2 is PT. Hence the payoffs of the
two portfolios are equal regardless of whether the stock price is below or
above the strike price.
PUT OPTION FORMULA

• Put option + Stock = Call option + PV of exercise price.


If Vc is the Black-Scholes value of the call option, then the value of a
put is

• For example, consider a put option written on the stock discussed


in the previous section. If the put option has the same exercise
price and expiration date as the call, then its price is
8.7 APPLICATION OF OPTION PRICING
IN CORPORATE FINANCE
Option Pricing is used in four major areas of
corporate finance:
1. Real Options Analysis for Project Evaluation and Strategic Decisions.
2. Risk Management.
3. Capital Structure Decision.
REAL OPTIONS ANALYSIS

• Real option is a way of applying option prices to the company by looking


at the opportunities that exist.

Ex: a company has a 1-year proprietary license to


develop a software application for use in a new
generation of wireless cellular telephones. Hiring
programmers and marketing consultants to
The good the
complete news is thatwill
project if consumers love the new
cost $30 million
cell phones, there will be a tremendous demand
for the software.
The license gives the company a real option,
because the underlying asset (the software) is a
real asset and not a financial asset.
RISK MANAGEMENT

Financial Risk Management is the practice of economic value in a firm by using financial
instruments to manage exposure to risk, include:
• Operational risk
• Credit Risk
This is focuses on when and how to
• Market risk hedge using financial instruments to
• Foreign Exchange Risk manage costly exposures to risk.
• Inflation Risk
• Business Risk
• Legal Risk
• Reputational Risk
CAPITAL STRUCTURE DECISION

The capital structure decision is how a firm finances its overall operations and
growth by using different sources of funds.

Debt comes in the form of bond issues or long-term notes payable, while
equity is classified as common stock, preffered stock, or retained earning.
Short-term debt such as working capital requirement is also considered to be
part of the capital structure.
THANK YOU

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