FM8e- ch13 - 13 - 1 CHAPTER 13 Option Pricing with...

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13 - 1 Financial options Black-Scholes Option Pricing Model Real options Decision trees Application of financial options to real options CHAPTER 13 Option Pricing with Applications to Real Options
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13 - 2 What is a real option? Real options exist when managers can influence the size and risk of a project’s cash flows by taking different actions during the project’s life in response to changing market conditions. Alert managers always look for real options in projects. Smarter managers try to create real options.
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13 - 3 An option is a contract which gives its holder the right, but not the obligation, to buy (or sell) an asset at some predetermined price within a specified period of time. What is a financial option?
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13 - 4 It does not obligate its owner to take any action. It merely gives the owner the right to buy or sell an asset. What is the single most important characteristic of an option?
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13 - 5 Call option : An option to buy a specified number of shares of a security within some future period. Put option : An option to sell a specified number of shares of a security within some future period. Exercise (or strike) price : The price stated in the option contract at which the security can be bought or sold. Option Terminology
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13 - 6 Option price : The market price of the option contract. Expiration date : The date the option matures. Exercise value : The value of a call option if it were exercised today = Current stock price - Strike price. Note: The exercise value is zero if the stock price is less than the strike price.
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13 - 7 Covered option : A call option written against stock held in an investor’s portfolio. Naked (uncovered) option : An option sold without the stock to back it up. In-the-money call : A call whose exercise price is less than the current price of the underlying stock.
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13 - 8 Out-of-the-money call : A call option whose exercise price exceeds the current stock price. LEAPS : Long-term Equity AnticiPation Securities that are similar to conventional options except that they are long-term options with maturities of up to 2 1/2 years.
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13 - 9 Exercise price = $25. Stock Price Call Option Price $25 $ 3.00 30 7.50 35 12.00 40 16.50 45 21.00 50 25.50 Consider the following data:
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13 - 10 Create a table which shows (a) stock price, (b) strike price, (c) exercise value, (d) option price, and (e) premium of option price over the exercise value. Price of Strike Exercise Value Stock (a) Price (b) of Option (a) - (b) $25.00 $25.00 $0.00 30.00 25.00 5.00 35.00 25.00 10.00 40.00 25.00 15.00 45.00 25.00 20.00 50.00 25.00 25.00
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13 - 11 Exercise Value Mkt. Price Premium of Option (c) of Option (d) (d) - (c) $ 0.00 $ 3.00 $ 3.00 5.00 7.50 2.50 10.00 12.00 2.00 15.00 16.50 1.50 20.00 21.00 1.00 25.00 25.50 0.50 Table (Continued)
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13 - 12 Call Premium Diagram 5 10 15 20 25 30 35 40 45 50 Stock Price Option value 30 25 20 15 10 5 Market price Exercise value
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13 - 13 What happens to the premium of the
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FM8e- ch13 - 13 - 1 CHAPTER 13 Option Pricing with...

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