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ch13boc-model - A 1 2 3 4 5 6 B C D E F G H I Worksheet for...

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1 of 9 Worksheet for Chapter 13 BOC Questions. Option Pricing and Real Options 3/17/03 Part 1. Financial Options Assume that put and call options exist on two stock, A and B, as shown below: Stock A Stock B Call Put Call Put Cost of the option $8.90 $8.90 $1.20 $1.20 Price of stock, P, at expiration $95.50 $95.50 $63.75 $63.75 Strike, or exercise, price, X $80.00 $80.00 $65.00 $65.00 Value of the option at expiration: $15.50 $0.00 $0.00 $1.25 Profit or loss on the option: $6.60 ($8.90) ($1.20) $0.05 Click fx > Logical > IF > OK. Then fill out the menu items as shown to get A's value. Copy this formula to B's column to get its call option value. Reverse the procedure to get the put options values. LOOKING AT EXERCISE AND MARKET VALUE OF AN OPTION Although it is easy to find an option's value at expiration, it is hard to determine the value before expiration, because there will exist a premium due to possible gains on the option. Consider the case of Space Technology, Inc. (STI) whose common stock is currently trading at $21 and whose call option strike price is $20. We treat the market prices for the option as given information that was read from the financial section of a newspaper. The last column--the premium-- represents the difference between the market prices and the exercise values of this option in these different states of the world. We graphed this relationship below. Part 1 of this model analyzes financial (stock) options. Part 2, shown on a separate worksheet, analyzes real options. A call option gives its holder the right to buy an asset at a predetermined price within a specified period of time, while a put option allows the holder to sell at the predetermined price. It is easy to determine the value of an option at the time of its expiration, as we demonstrate just below. It is harder, but possible, to estimate the option's value prior to its expiration, as we demonstrate later in the spreadsheet. Question 1. We go through the following model to show how financial options are valued using Black-Scholes. The effects of the 5 factors are shown. The sensitivity of the model can also be used in a discussion of expensing optionss The holder of an option can exercise or not exercise it, and exercise will occur only if it is profitable to do so. We can use this fact to evaluate the options shown above. We use Excel's IF function, as explained below. A B C D E F G H I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46
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2 of 9 Option Value Price of Strike Exercise Market the stock Price Value Price Premium $0.00 $20.00 $0.00 $4.50 $4.50 $10.00 $20.00 $0.00 $6.00 $6.00 $20.00 $20.00 $0.00 $9.00 $9.00 $21.00 $20.00 $1.00 $9.75 $8.75 $22.00 $20.00 $2.00 $10.50 $8.50 $35.00 $20.00 $15.00 $21.00 $6.00 $42.00 $20.00 $22.00 $26.00 $4.00 $50.00 $20.00 $30.00 $32.00 $2.00 $73.00 $20.00 $53.00 $54.00 $1.00 $98.00 $20.00 $78.00 $78.50 $0.50 Three factors drive the premium: (1) The option's term to maturity, (2) the variability of the stock price, and (3) the In deriving their model, Black and Scholes made the following assumptions: 1. The stock underlying the call option pays no dividends.
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