Unformatted text preview: cial assets the price of an option should equal the expected value of the option. However,
unlike other financial assets it is impossible to figure out expected cash flows and discount them using the
opportunity cost of capital as discount rate. In particular the latter is impossible, as the risk of an option
changes every time the underlying stock price moves.
Black and Scholes solved this problem by introducing a simple option valuation model, which applies the
principle of value additivity to create an option equivalent. The option equivalent is combining stocks and
borrowing, such that they yield the same payoff as the option. As the value of stocks and borrowing
arrangements is easily assessed and they yield the same payoff as the option, the price of the option must
equal the combined price on the stock and borrowing arrangement. Download free ebooks at bookboon.com
79 Corporate Finance Options Example:
- How to set up an option equivalent
Consider a 3-month Google call option issued at the money wi...
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