REAL OPTION VS FINANCIAL OPTIONS The specific characteristics which from FINANCE MISC at Moi University Real options may be classified into different groups. • Marketable and traded security with comparables and pricing info. In the trading of assets, an investor can take two types of positions: long and short. This is because the volatility measures used in options modeling pertain to the underlying variable. • Management assumptions and actions have no bearing on valuation. Major million and billion dollar decisions. The long put option position or the buyer and holder of a put option is akin to an abandonment option. To study the complex nature and interactions between options and the underlying asset, we present an options case study. For example, financial options have short maturities, usually expiring in several months. Longer maturity, usually in years. • Underlying variable driving its value is equity price or price of a financial asset. Real options tend to be based on non-market-traded assets, and financially traded proxies are seldom available. �*)s-����G:��}�IdD���DX�=������T�V5ȭie0vKr��((������, �(ߦ�̔�6K���P��LTA�P��7=���^z�MM:KLD,"�B��Be�?tm�=����_�KF�F}��0L�l�nS��ʧ!��e�� M��?�}�V��=��c��`�0Qh"��/�o��)߸S'�erKa���*���i��}��c� %FU�hS�ܱ���$א��`�k��#2�s�֫��Ȁ����� ��:}����� �m,�T� exO��V�� ��}�y�L��N���-� ����m ��@9��" Җ��K�PzR4=�=#�y�� 쐶��������C���Q�|~��R�͕��m�{w�-�0�V:Q�䔻�� Real Options versus Financial Options. If the underlying asset does not increase in value over time, the maximum losses incurred by the holder of this expansion option will be the cost of setting up this option (e.g., market research cost). NPV = F / [ (1 + r)^n ] where, PV = Present Value, F = Future payment (cash flow), r = Discount rate, n = the number of periods in the future is the most straightforward approach to real options pricing. An investor can either buy an asset (going long), or sell it (going short). The underlying asset in financial options is the stock price, as compared to a multitude of other business variables in real options. 3 0 obj Fortunately, the pricing of financial options approaches can be applied to price the real options. �q�7�B6��}��N�^�Ϥ&. These short positions reflect the side of the issuer of the option. Thus, when applying real options analysis to analyzing physical assets, we have to be careful in discerning what the underlying variable is. Projecting income statement line items begins with sales revenue, then cost, Projecting balance sheet line items involves analyzing working capital, PP&E, debt share capital and net income. Real options in capital budgeting allow a company’s management to make future decisions that may change the value of capital budgeting decisions made today. That’s because they offer increased flexibility. There is unlimited upside to this option, but the downside is limited to the premium paid for the option. This is because an abandonment option usually costs something to create or set up, which is akin to the option's premium or purchase price. A right, but not an obligation, to make a business decision, EBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. However, in real options, because certain strategic options can be created by management, their decisions can increase the value of the project's real options. Usually solved using closed-form equations and binomial lattices with simulation of the underlying variables, not on the option analysis. Both put and call options have different payouts. It's important to understand exactly how the NPV formula works in Excel and the math behind it. As for example, the option to expand can be viewed as a call option, while the option to abandon can be viewed as a put option. Real options may be classified into different groups. x���r���3�>��% ^�N���ɦ������nh��ٕ%����O�_�� � 9�Y"� �~ �����2i��QQUIZGƨ��#��yԷ�W���������ߪ ���P��T�:�P�$����)��w�WVQ����O�W��$tT{�ĺ��2KRM�V��U��|u��z���|�F�Z���稔i�*��>^�i�؀$�b�!�P�_��U�Ï����]�rB���ai���E:ڌYlFWE��/�Rl��҇�����J��*EI|���c��C��*�l����m.������{5�J*o�Q

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