Banking Chapter 21 Option Valuation Outline The Following Outline Correlated The Powerpoint

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Chapter 21

Option Valuation

I. Chapter Outline

The following chapter outline is correlated to the PowerPoint Lecture Slides. The PowerPoint slides

are referenced in bold. Alternative Examples to selected textbook examples are also available in the

PowerPoint Lecture Slides and are also referenced in bold.

21.1 The Binomial Option Pricing Model (Slide 7)

• A Two-State Single-Period Model (Slides 8–16)

• Figure 21.1 Replicating an Option in the Binomial Model (Slide 17)

• The Binomial Pricing Formula (Slides 18–20)

• Example 21.1 Valuing a Put Option (Slides 21–22)

• PowerPoint Alternative Example 21.1 (Slides 23–34)

• A Multiperiod Model (Slides 25–34)

• Example 21.2 Using the Binomial Option Pricing Model to Value a Put Option (Slides

35–37)

21.2 The Black-Scholes Option Pricing Model (Slide 40)

• The Black-Scholes Formula (Slides 41–42, 44, 51, 57-59)

• Figure 21.3 Normal Distribution (Slide 43)

• Interview with Myron S. Scholes

• Example 21.3 Valuing a Call Option with the Black-Scholes Formula (Slides 45–47)

• PowerPoint Alternative Example 21.3 (Slides 48–49)

• Table 21.1 JetBlue Option Quotes (Slide 46)

– European Put Options (Slide 51)

• Figure 21.4 Black-Scholes Value on July 24, 2009 of the December 2009 $6 Call on

JetBlue Stock (Slide 50)

• Example 21.4 Valuing a Put Option with the Black-Scholes Formula (Slides 52–53)

• PowerPoint Alternative Example 21.4 (Slides 54–55)

• PowerPoint Alternative Example 21.5 (Slides 63–64)

• Implied Volatility (Slide 65)

Berk/DeMarzo • Corporate Finance, Fourth Edition, Global Edition 91

• Example 21.6 Computing the Implied Volatility from an Option Price (Slides 66–67)

• Global Financial Crisis: The VIX Index

21.3 Risk-Neutral Probabilities (Slide 75)

• A Risk-Neutral Two-State Model (Slides 76–79)

• Implications of the Risk-Neutral World (Slides 80–85)

• Risk-Neutral Probabilities and Option Pricing (Slides 86–87, 91–92)

• Example 21.8 Option Pricing with Risk-Neutral Probabilities (Slides 88–90)

21.4 Risk and Return of an Option (Slides 93, 96)

21.5 Corporate Applications of Option Pricing (Slide 99)

• Beta of Risky Debt (Slides 99–100)

• Figure 21.9 Beta of Debt and Equity (Slide 101)

• Example 21.10 Computing the Beta of Debt (Slides 102–103)

• Agency Costs of Debt (Slide 104)

II. Learning Objectives

21-2 Define the replicating portfolio for the Binomial Option Pricing Model.

21-4 Use the Black-Scholes Option Pricing formula to calculate the value of a call option on a non-

dividend-paying stock.

21-6 Compute the value of a European option on a dividend-paying stock.

21-8 Discuss what is meant by risk-neutral probabilities, and show how these probabilities can be

used to price any other asset for which the payoffs in each state are known.

21-10 Calculate and interpret the beta of an option.

21-11 Use the Black-Scholes formula to unlever the equity beta of a firm and find the beta of debt.

92 Berk/DeMarzo • Corporate Finance, Fourth Edition, Global Edition

III. Chapter Overview

The chapter discusses how options are valued using the Binomial Option Pricing Model, the Black–

Scholes formula, and risk-neutral probabilities. The authors emphasize the reliance of these formulas

on the Law of One Price.

21.1 The Binomial Option Pricing Model

This section begins with a two-state single-period model. The authors show how to form a replicating

portfolio, and show that the price is not a function of the probabilities of the states in the binomial

21.2 The Black-Scholes Option Pricing Model

Rather than deriving the Black-Scholes formula, the authors state it (Equation 21.7) and discuss its

implications. Example 21.3 shows how to value a call option with the Black-Scholes formula. The

authors then show how to compute the price of a European put on a non-dividend-paying stock using

21.3 Risk-Neutral Probabilities

21.4 Risk and Return of an Option

This section discusses the beta of an option, using the fact that, for a call option, the replicating

21.5 Corporate Applications of Option Pricing

The final section of this chapter shows how the previous information can be used to calculate the beta

IV. Spreadsheet Solutions in Excel

There are no spreadsheet solutions for this chapter.