Ch 8 Slide Show - Chapter8 FinancialOptionsand 1...

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1 Chapter 8 Financial Options and  Applications in Corporate Finance
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2 Topics in Chapter Financial Options Terminology Option Price Relationships Black-Scholes Option Pricing Model Put-Call Parity
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3 Stock Price =                  +                 +      + D 1 D 2 D (1 + r s  ) 1 (1 + r s ) (1 + r s ) 2 Dividends (D t ) Risk-free bond Portfolio of stock and  risk-free bond that replicates cash flows of the option Value of option must be the same as the  replicating portfolio Cost of  equity (r s ) The Big Picture: The Value of a Stock Option ...
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4 What is a financial option? 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.
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5 What is the single most important characteristic of an option? It does not obligate its owner to take  any action.  It merely gives the owner  the right to buy or sell an asset.
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6 Option Terminology 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.
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7 Option Terminology Strike (or exercise) price:  The price  stated in the option contract at which  the security can be bought or sold. Expiration date:  The last date the  option can be exercised. 
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8 Option Terminology  (Continued) Exercise value:  The value of a call  option if it were exercised today = Max[0, Current stock price - Strike price] Note:  The exercise value is zero if the  stock price is less than the strike price. Option price:  The market price of the  option contract.
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9 Option Terminology  (Continued) Time value: Option price minus the  exercise value. It is the additional value  because the option has remaining time  until it expires.
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10 Option Terminology  (Continued) Writing a call option: For every new  option, there is an investor who “writes”  the option. A writer creates the contract, sells it to  another investor, and must fullfill the option  contract if it is exercised.  For example, the writer of a call must be  prepared to sell a share of stock to the  investor who owns the call.
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11 Option Terminology  (Continued) Covered option:  A call option written  against stock held in an investor’s  portfolio.
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