1、CHAPTER 23OPTIONS AND CORPORATE FINANCECopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-2 Lay out the basics of call and put options and explain how to calculate their payoffs and profits List the f
2、actors that affect option values and show how to price call and put options using no arbitrage conditions Explain the basics of employee stock options and their benefits and disadvantages Value a firms equity as a call option on the firms assets Value options in capital budgeting projects,including
3、timing options,the option to expand,the option to abandon,and the option to contract Define the basics of convertible bonds and warrants and how to value themCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Educ
4、ation.KEY CONCEPTS AND SKILLS23-3 Options:The Basics Fundamentals of Option Valuation Valuing a Call Option Employee Stock Options Equity as a Call Option on the Firms Assets Options and Capital Budgeting Options and Corporate SecuritiesCHAPTER OUTLINECopyright 2019 McGraw-Hill Education.All rights
5、reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-4 Call Put Strike or Exercise price Expiration date Option premium Option writer American Option European OptionOPTION TERMINOLOGYCopyright 2019 McGraw-Hill Education.All rights reserved.No reprodu
6、ction or distribution without the prior written consent of McGraw-Hill Education.23-5 Look at Table 23.1 in the book.Price and volume information for calls and puts with the same strike and expiration is provided on the same line.Things to notice Prices are higher for options with the same strike pr
7、ice but longer expirations.Call options with strikes less than the current price are worth more than the corresponding puts.Call options with strikes greater than the current price are worth less than the corresponding puts.STOCK OPTION QUOTATIONSCopyright 2019 McGraw-Hill Education.All rights reser
8、ved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-6 The value of the call at expiration is the intrinsic value.Max(0,S-E)S is the underlying asset price E is the exercise price If SE,then the payoff is S E Assume that the exercise price is$30.051015202
9、50102030405060Call ValueStock PriceCall Option Payoff DiagramOPTION PAYOFFS CALLSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-7 The value of a put at expiration is the intrinsic value.Max(0,E-S)
10、If SE,then the payoff is 0 Assume that the exercise price is$30.051015202530350102030405060Option ValueStock PricePayoff Diagram for Put OptionsOPTION PAYOFFS PUTSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill
11、 Education.23-8 Where can we find option prices?On the Internet,of course.One site that provides option prices is Yahoo!Finance.Go to Yahoo!Finance.Enter a ticker symbol,then click on the options tab to get a basic quote.WORK THE WEB EXAMPLECopyright 2019 McGraw-Hill Education.All rights reserved.No
12、 reproduction or distribution without the prior written consent of McGraw-Hill Education.23-9 Upper bound Call price must be less than or equal to the stock price.Lower bound Call price must be greater than or equal to the stock price minus the exercise price or zero,whichever is greater(i.e.,the op
13、tions intrinsic value).If either of these bounds are violated,there is an arbitrage opportunity.CALL OPTION BOUNDSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-10 FIGURE 23.2Copyright 2019 McGraw
14、-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-11 An option is“in-the-money”if the payoff is greater than zero.If a call option is sure to finish in-the-money,the option value would be:C0=S0 PV(E)If the call is worth
15、something other than this,then there is an arbitrage opportunity.A SIMPLE MODELCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-12 Stock price As the stock price increases,the call price increases a
16、nd the put price decreases.Exercise price As the exercise price increases,the call price decreases and the put price increases.Time to expiration Generally,as the time to expiration increases,both the call and the put prices increase.Risk-free rate As the risk-free rate increases,the call price incr
17、eases and the put price decreases.WHAT DETERMINES OPTION VALUES?Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-13 When an option may finish out-of-the-money(expire without being exercised),there i
18、s another factor that helps determine price.The variance in underlying asset returns is a less obvious,but important,determinant of option values.The greater the variance,the more the call and the put are worth.If an option finishes out-of-the-money,the most you can lose is your premium,no matter ho
19、w far out it is.The more an option is in-the-money,the greater the gain.The owner of the option gains from volatility on the upside,but dont lose any more from volatility on the downside.WHAT ABOUT VARIANCE?Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution with
20、out the prior written consent of McGraw-Hill Education.23-14 TABLE 23.2Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-15 Call options that are given to employees as part of their benefits packages
21、 Often used as a bonus or incentive Designed to align employee interests with stockholder interests and reduce agency problems Empirical evidence suggests that they dont work as well as anticipated due to the lack of diversification introduced into the employees portfolios.The stock isnt worth as mu
22、ch to the employee as it is to an outside investor because of the lack of diversification this suggests that options may work in limited amounts,but not as a large part of the compensation package.EMPLOYEE STOCK OPTIONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distr
23、ibution without the prior written consent of McGraw-Hill Education.23-16 Equity can be viewed as a call option on the companys assets when the firm is leveraged.The exercise price is the face value of the debt.If the assets are worth more than the debt when it comes due,the option will be exercised
24、and the stockholders retain ownership.If the assets are worth less than the debt,the stockholders will let the option expire and the assets will belong to the bondholders.EQUITY AS A CALL OPTIONCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior
25、 written consent of McGraw-Hill Education.23-17 Almost all capital budgeting scenarios contain implicit options.A real option is an option that involves real assets as opposed to financial assets such as shares of stock.Because options are valuable,they make the capital budgeting project worth more
26、than it may appear.Failure to account for these options can cause firms to reject good projects.CAPITAL BUDGETING OPTIONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-18 We normally assume that a
27、 project must be taken today or forgone completely.Many projects have the embedded option to wait.A good project may be worth more if we wait.A seemingly bad project may actually have a positive NPV if we wait due to changing economic conditions.We should examine the NPV of taking an investment now,
28、or in future years,and plan to invest at the time that the project produces the highest NPV.THE INVESTMENT TIMING DECISIONCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-19 Consider a project that
29、costs$5,000 and has an expected future cash flow of$700 per year forever.If we wait one year,the cost will increase to$5,500 and the expected future cash flow will increase to$800.If the required return is 13%,should we accept the project?If so,when should we begin?NPV starting today=-5,000+700/.13=
30、384.62 NPV waiting one year=(-5,500+800/.13)/(1.13)=578.62 It is a good project either way,but we should wait until next year to maximize the NPV.EXAMPLE:TIMING OPTIONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw
31、-Hill Education.23-20 Managers often have options that can add value after a project has been implemented.It is important to do some contingency planning ahead of time to determine what will cause the options to be exercised.Some examples include:The option to expand a project if it goes well The op
32、tion to abandon a project if it goes poorly The option to suspend or contract operations,particularly in the manufacturing industries Strategic options look at how taking a project might open up other opportunities that would be otherwise unavailableMANAGERIAL OPTIONSCopyright 2019 McGraw-Hill Educa
33、tion.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-21 A call option issued by corporations in conjunction with other securities to reduce the yield required on the other securities Differences between warrants and traditional call o
34、ptions:Warrants are generally very long term.They are written by the company,and warrant exercise results in additional shares outstanding.The exercise price is paid to the company,generates cash for the firm,and alters the capital structure.Warrants can normally be detached from the original securi
35、ties and sold separately.Exercise of warrants reduces EPS,so warrants are included when a firm reports“diluted EPS.”WARRANTSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-22 Convertible bonds(or c
36、onvertible preferred stock)may be converted into a specified number of common shares at the option of the bondholder.The conversion price is the effective price paid for the stock.The conversion ratio is the number of shares received when the bond is converted.Convertible bonds will be worth at leas
37、t the straight bond value or the conversion value,whichever is greater.CONVERTIBLESCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-23 Suppose you have a 10%bond that pays semiannual coupons and wil
38、l mature in 15 years.The face value is$1,000,and the yield to maturity on similar bonds is 9%.The bond is also convertible with a conversion price of$100.The stock is currently selling for$110.What is the minimum price of the bond?Straight bond present value=$1,081.44 Conversion ratio=1,000/100=10 C
39、onversion value=10$110=$1,100 Minimum price=Max($1,081.44,$1,100)=$1,100VALUING CONVERTIBLESCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-24 Call provision on a bond Allows the company to repurch
40、ase the bond prior to maturity at a specified price that is generally higher than the face value Increases the required yield on the bond this is effectively how the company pays for the option Put bond Allows the bondholder to require the company to repurchase the bond prior to maturity at a fixed
41、price Insurance and Loan Guarantees Loan guarantees are a form of insurance.If you lend money to someone and they default,then,with a guaranteed loan,you can collect from someone else,often the government.OTHER OPTIONSCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distri
42、bution without the prior written consent of McGraw-Hill Education.23-25 What is the difference between a call option and a put option?What is the intrinsic value of call and put options,and what do the payoff diagrams look like?What are the five major determinants of option prices and their relation
43、ships to option prices?What are some of the major capital budgeting options?How would you value a convertible bond?QUICK QUIZCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-26 It has been reported
44、that during the internet boom in the late 1990s,technology firms were increasing their earnings by selling put options on their own stock.When is this practice beneficial for the firm?Why do you think this practice was significantly reduced in the year 2000?Is there any ethical implication of this p
45、ractice?ETHICS ISSUESCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-27 A convertible bond has a straight bond value of$1,050.The conversion ratio is 23,and the stock price is$49 per share.What is
46、the value of the option to convert?What is the intrinsic value of a call and a put,each with an exercise price of$40,if the stock price is currently$50?What if the stock price is$20?COMPREHENSIVE PROBLEMCopyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.23-28 END OF CHAPTERCHAPTER 23Copyright 2019 McGraw-Hill Education.All rights reserved.No reproduction or distribution without the prior written consent of McGraw-Hill Education.
