Lecture Note Three_Tsing Hua_2009 - Lecture Note 3 Options...

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Corporate Finance Lecture Note 3 1 Lecture Note 3 Options and Corporate Finance
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Corporate Finance Lecture Note 3 2 What is in This Note? Overview of Types of Options Overview of Binominal Option Pricing Overview of The Black-Scholes Model Overview of Debt and Equity as Options Reference: Chapter 22 of RWJJ, Chapters 20 and 21 of BMA
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Corporate Finance Lecture Note 3 3 Please review Options, Futures, and Other Derivatives, Six Edition, by John C. Hull, Prentice- Hall, 2006, Chapters 8, 9,11, 12, and 13 Please review your class notes on o&& ,
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Corporate Finance Lecture Note 3 4 Understand Option
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Corporate Finance Lecture Note 3 5 Roadmap Understand option terminology Options Call Options Put Options Combinations of Options Be able to determine option payoffs and profits
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Corporate Finance Lecture Note 3 6 Options An option gives the holder the right, but not the obligation , to buy or sell a given quantity of an asset on (or before) a given date, at prices agreed upon today. Exercising the Option The act of buying or selling the underlying asset Strike Price or Exercise Price (K) Refers to the fixed price in the option contract at which the holder can buy or sell the underlying asset Expiry (Expiration Date:T) The maturity date of the option
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Corporate Finance Lecture Note 3 7 Options European versus American options European options can be exercised only at expiry. American options can be exercised at any time up to expiry. In-the-Money Exercising the option would result in a positive payoff. At-the-Money Exercising the option would result in a zero payoff (i.e., exercise price equal to spot price). Out-of-the-Money Exercising the option would result in a negative payoff.
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Corporate Finance Lecture Note 3 8 Option Traders Buyer Seller Call option Right to buy asset Obligation to sell asset Put option Right to sell asset Obligation to buy asset
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Corporate Finance Lecture Note 3 9 Call Options Call options gives the holder the right, but not the obligation, to buy a given quantity of some asset on or before some time in the future, at prices agreed upon today. When exercising a call option, you “call in” the asset.
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Corporate Finance Lecture Note 3 10 Call Option Pricing at Expiry At expiry, an American call option is worth the same as an European option with the same characteristics. – If the call is in-the-money, it is worth S T K. If the call is out-of-the-money, it is worthless: C T = Max[ S T K , 0] Where S T is the value of the stock at expiry (time T ) K is the exercise price. C T is the value of the call option at expiry
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Corporate Finance Lecture Note 3 11 Call Option Buyer’s Payoffs at Time T: C T = Max[ S T K , 0] –20 120 20 40 60 80 100 –40 20 40 60 Stock price ($) Option payoffs ($) Buy a call Exercise price = $50 50
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Corporate Finance Lecture Note 3 12 Call Option Buyer’s Profits Time T : C T C 0 or C T C 0 e rT Exercise price = $50; option premium = $10 Buy a call –20 120 20 40 60 80 100 –40 20 40 60 Stock price ($) Option payoffs ($) 50 –10 10
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This note was uploaded on 04/18/2010 for the course FINANCE 936116531 taught by Professor Wuyiling during the Spring '10 term at Nashville State Community College.

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Lecture Note Three_Tsing Hua_2009 - Lecture Note 3 Options...

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