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Chapter 24 - Options and Corporate Finance
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Chapter 24
OPTIONS AND CORPORATE FINANCE
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
24.1 Options: The Basics
24.2 Fundamentals of Option Valuation
24.3 Valuing a Call Option
24.4 Employee Stock Options
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ANNOTATED CHAPTER OUTLINE
24.1. Options: The Basics
A. Puts and Calls
Lecture Tip: You may wish to emphasize the symmetrical nature of
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B. Stock Option Quotations
Chicago Board Options Exchange (CBOE) – the largest organized stock
Lecture Tip: There has been a great deal of innovation in the derivatives
field over the years. In the options area, a number of interesting twists on
Lecture Tip: Students are often fascinated by the topics of hedging and
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Lecture Tip: You might want to point out that the strike prices in listed
C. Option Payoffs
Lecture Tip: Although the concepts are similar for puts and calls, students
generally have more difficulty working with puts. An example showing
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At expiration, the put value will be equal to max(0, E – S). If the strike
Example: Consider options with a strike price of $30.
24.2. Fundamentals of Option Valuation
A. Value of a Call Option at Expiration
B. The Upper and Lower Bounds on a Call Option’s Value
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Lecture Tip: You may want to discuss the importance of arbitrage in the
valuation of options. The classic definition of arbitrage is trading in more
Lecture Tip: The phrase “intrinsic value” is important in the field of
C. A Simple Model: Part I
One way to illustrate option pricing is to show equivalent cash flows with
different sets of securities.
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D. Four Factors Determining Option Values
24.3. Valuing a Call Option
A. A Simple Model: Part II
So, your two possible portfolios are:
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B. The Fifth Factor
C. A Closer Look
24.4. Employee Stock Options
Employee Stock Options (ESOs) allow employees to purchase company stock at a
fixed price for a fixed amount of time.
A. ESO Features
Features differ from company to company, but here are some common
ones.
-Typical expiration of 10 years
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Lecture Tip: The idea behind using stock options to align management
interests with stockholder interests is a noble one. Many companies have
embraced it wholeheartedly because it seems so logical. However,
B. ESO Repricing
When the stock price falls well below the strike price on an employee
C. ESO Backdating
In 2006, a scandal erupted because it was found that companies had a
24.5. Equity as a Call Option on the Firm’s Assets
The underlying asset is the value of the firm (the value of its assets). The
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A. Case I: The Debt is Risk-Free
The option will be in-the-money: Suppose the assets are worth $1,000 (=
B. Case II: The Debt is Risky
Suppose all circumstances are the same as above except that the firm’s
assets will be worth either $900 or $1,700 in one period. How much are
the debt and the equity worth?
Lecture Tip: Option valuation can explain why companies may have
incentive to take on projects with negative NPV. Consider the following
example:
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24.6. Options and Capital Budgeting
Real options provide the right to buy or sell real assets. These options often apply
in capital budgeting situations and can be very valuable.
A. The Investment Timing Decision
Virtually all projects can be viewed as real options if you think of the
B. Managerial Options
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24.7. Options and Corporate Securities
A. Warrants
B. Convertible Bonds
Chapter 24 - Options and Corporate Finance
C. Other Options
Callable bond – many corporate bonds are callable, meaning that the
24.8. Summary and Conclusions
