Premium Essay

Options and Corporate Finance

In: Business and Management

Submitted By littlefighter
Words 20387
Pages 82
Fundamentals of Corporate Finance by Robert Parrino and David S. Kidwell John Wiley & Sons, Inc.. (c) 2009. Copying Prohibited.

Reprinted for Krishna Chebolu, Bank of America Chebolu.Krishna@bankofamerica.com Reprinted with permission as a subscription benefit of Books24x7, http://www.books24x7.com/

All rights reserved. Reproduction and/or distribution in whole or in part in electronic,paper or other forms without written permission is prohibited.

i

Table of Contents
Chapter 20: Options and Corporate Finance................................................................................1 Overview................................................................................................................................1 20.1 Financial Options...........................................................................................................2 Call Options ......................................................................................................................2 Put Options......................................................................................................................5 American, European, and Bermudan Options.................................................................6 More on the Shapes of Option Payoff Functions.............................................................7 20.2 Option Valuation............................................................................................................8 Limits on Option Values...................................................................................................8 Variables That Affect Option Values..............................................................................10 The Binomial Option Pricing Model ...............................................................................12 . Put-Call…...

Similar Documents

Premium Essay

Corporate Finance

... the higher the firm’s fixed cost the greater its Operating Leverage. In Jacque’s words, this has to do with volatility of the top line. Those firms are usually highly automated, capital intensive, hire highly skilled individuals (read pay them huge salaries), and engage into costly R&D activities. Effects of Operating Leverage on Business Risk: (if all other things held constant) the higher a firm’s Operating Leverage, the higher its business risk. This is because in lower economical cycles, the firm will still be incurring its fixed cost. However, remember that higher risk usually commands for a higher return on investment. Financial leverage is the use of debt to finance the activities of a business. Financial risk is the additional risk put on the shareholder when management decides to finance with debt. The more debt a firm takes on, the more concentrated the business risk on the shareholder because the shareholder is a residual claimant. This results in a higher expected rate of return on the investment by the shareholder. Consequences of an increase in leverage (Leverage ↑): * Expected ROE ↑ * Stockholder risk ↑ * Standard deviation ↑ * Coefficient of variation ↑ 2) Cash-Flow statement and valuation: Natalia Cash-Flow Statement and valuation Cash-Flow Statement: * reflects firm’s sources and uses of cash during an accounting period; since not based * breaks cashflows down into three categories: * Cash-Flow from Operations......

Words: 8553 - Pages: 35

Premium Essay

Corporate Finance

...Applied Corporate Finance | | | Submitted to: Mr.Asif MalikSubmitted by: Sana AmjadRoll no. 12L-5284MBA | | | | Department of management sciences | | The purpose of this assignment is to solve and study IPO in detail and provide the necessary solutions to it. Internet has been also used with referencing to seek out the solutions. Table of Contents Content | Page no: | Question A | 4 | Question B | 5 | Question C | 10 | Question D | 12 | References | | Question A: The IPO process is characterized by information asymmetries. Explain how these asymmetries may be reduced through the book-building process. IPO (initial public offering):- The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.IPO process, are asymmetrically informed as managers and internal subjects posses private information about the firm's future prospects which may be not completely known to external investors. The process by which an underwriter attempts to determine at what price to offer an IPO based on demand from institutional investors...

Words: 4277 - Pages: 18

Premium Essay

Corporate Finance

...12/6/2012 Chapter 24 Options and Corporate Finance Key Concepts and Skills • Understand the options terminology • Be able to determine option payoffs and pricing bounds • Understand the five major determinants of option value • Understand employee stock options • Understand the various managerial options • Understand the differences between warrants and traditional call options • Understand convertible securities and how to determine their value 1 12/6/2012 Chapter Outline • • • • • • • Options: The Basics Fundamentals of Option Valuation Valuing a Call Option Employee Stock Options Equity as a Call Option on the Firm’s Assets Options and Capital Budgeting Options and Corporate Securities Option Terminology • • • • • • • • Call Put Strike or Exercise price Expiration date Option premium Option writer American Option European Option 2 12/6/2012 Stock Option Quotations • Look at Table 14.1 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 price 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 22.5 Option Quotes Option/Strike Exp. IBM 130 Oct 138¼ 130 Jan 138¼ 135 Jul 138¼ 135 Aug 138¼ 140 Jul 138¼ 140 Aug......

Words: 2051 - Pages: 9

Premium Essay

Corporate Finance

...unfavorable image would than fall back on management. So the selling on the secondary market can help dictate the rate of the company’s own held shares and be a reflection on how well management is doing on ensuring they “maximize the current value per share of the existing stock” (Ross, Westerfield & Jaffe, 2013, p. 12). Also, many managers possess what is known as either stock options or salary incentives within their company. As stated on Investopedia (2011) “ Too often investors forget that stock means ownership. The job of management is to produce gains for the shareholders. Although a manager has little or no control of share price in the short run, poor stock performance could, over the long run, be attributed to mismanagement of the company. If the stock price consistently underperforms the shareholders' expectations, the shareholders are going to be unhappy with the management and look for changes” (para. 4). This is why IBM’s management cares about the price one gets for their shares in the secondary market. References Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013). Corporate finance, (10th ed.). New York: McGraw-Hill Irwin. Why do companies care about their stock prices? (2011, August 28). Investopedia. Retrieved from http://www.investopedia.com...

Words: 427 - Pages: 2

Premium Essay

Corporate Finance

... Corporate Finance 10 Problems From Chapter 1 through 10 Sorang Kim BHU MBA 671 Corporate Finace Professor Mensah Dartey April 14, 2013 Chapter 1, Problem 6 (pp. 6 ~ 8) Problem You are a shareholder in a C corporation. The corporation earns $2 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. How much is left for you after all taxes are paid? Solution Profit after corporate taxes=corporate earnings*(1-corporate tax rate) =2*(1-0.4)=1.2 Profit after personal taxes=profit after corporate taxes*(1-personal taxes) =1.2*(1-0.3)=0.84 The true profit received by shareholder after payment of all taxes in C corporate is $0.84. Chapter 2, Problem 9 (pp.26~28) Problem In July 2007, Apple had cash of $7.12 billion, current assets of $18.75 billion, current liabilities of $6.99 billion, and inventories of $0.25 billion. Solution a. Market capitalization Current ratio=current asset/current liabilities =18.75/6.99=2.682 b. Quick ratio=(current asset-current inventories)/current liabilities =(18.75-0.25)/6.99=2.646 c. DLL quick ratio=1.25 DLL current ratio=1.3 As compare to DLL, APP has more ideal current asset. An ideal current asset to meet all short term debt obligation is 2:1. And APP has more liquidity to pay their short term requirements......

Words: 1568 - Pages: 7

Premium Essay

Corporate Finance

...1.0 Introduction Capital markets are a major source of finance for large companies engaging in investment projects. Successful investment projects can bring tremendous returns to shareholders in the form of dividend payment and increased share value. However, the source of finance affects a company’s overall cost of capital and by extension its dividends to shareholders. This report addresses the importance of the capital market and the efficient market hypothesis theories. The various source of finance available to large companies and the related cost. As well as the importance of the dividend decision and its possible affect on the company’s share price. [pic] 2.0 The role and importance of capital markets and efficient market hypothesis (EMH) [pic] The Role and Importance of Capital Markets A capital market is a market for the trading of long term securities such as, but not limited to debt and equity securities. A capital market which includes bond markets and stock exchanges serves two major functions. Firstly, it acts as a primary market for issuing new equity and debt capital. This means that companies[1] who want to raise new financing for investment projects or business expansion can source funding via this market. Secondly, it also acts as a secondary market for trading (that is to say buying and selling) of existing securities. The secondary market also serves as a source of pricing information for the primary market. Capital markets provide......

Words: 4989 - Pages: 20

Premium Essay

Corporate Finance

...To what extent is it true that as a result of agency costs shareholders wealth will not be maximized by corporate management. If so, what actions can shareholders take to correct the situation? As we know that agency costs exists in most corporations since the separation of ownership and management in large businesses. Shareholders are the principals and owners; managers are the stockholders’ agents. The problem is to get between shareholders and managers since they have different objectives. Shareholders’ goals are maximizing firms’ value, managers’ goals are benefit themselves, thus the conflicts rise in the company. In this report through concept of agency costs and analysis that two questions will be discussed. First, to what extent that as a result of agency costs shareholders wealth will not be maximized by corporate management. I will talk the agency costs in the conflict of interest between shareholders and management through analysis and lots of examples. Second I will discuss the actions that shareholders take to reduce the agency costs, and achieve their wealth maximizing. According to Hickman (1996), there are always separation of ownership and management in large businesses. Major corporations may have a large number of shareholder, these shareholders have no way to be actively involved in management so that they hire professional managers to manage the corporations. Shareholders put their money in corporations because they......

Words: 1653 - Pages: 7

Premium Essay

Corporate Finance

...Corporate Finance, 9/e Stephen A. Ross, Massachussetts Institute of Technology Randolph W. Westerfield, University of Southern California Jeffrey F. Jaffe, University of Pennsylvania ISBN: 0073382337 Copyright year: 2010 Table of Contents PART I: Overview 1 Introduction to Corporate Finance 1 1.1 | What Is Corporate Finance? | 1 | | The Balance Sheet Model of the Firm | 1 | | The Financial Manager | 3 | 1.2 | The Corporate Firm | 4 | | The Sole Proprietorship | 4 | | The Partnership | 4 | | The Corporation | 5 | | A Corporation by Another Name . . . | 7 | 1.3 | The Importance of Cash Flows | 7 | 1.4 | The Goal of Financial Management | 10 | | Possible Goals | 11 | | The Goal of Financial Management | 11 | | A More General Goal | 12 | 1.5 | The Agency Problem and Control of the Corporation | 13 | | Agency Relationships | 13 | | Management Goals | 14 | | Do Managers Act in the Stockholders' Interests? | 14 | | Stakeholders | 15 | 1.6 | Regulation | 16 | | The Securities Act of 1933 and the Securities Exchange Act of 1934 | 16 | | Sarbanes-Oxley | 17 | | Summary and Conclusions | 18 | | Concept Questions | 18 | | S&P Problems | 19 | 2 Financial Statements and Cash Flow 20 2.1 | The Balance Sheet | 20 | | Liquidity | 21 | | Debt versus Equity | 22 | | Value versus Cost | 22 | 2.2 | The Income Statement | 23 | | Generally Accepted Accounting Principles | 24 | | Noncash Items |......

Words: 4966 - Pages: 20

Premium Essay

Corporate Finance

... CORPORATE FINANCE T H IRD E DIT ION JONATHAN BERK STANFORD UNIVERSITY PETER D E MARZO STANFORD UNIVERSITY Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo To Rebecca, Natasha, and Hannah, for the love and for being there —J. B. To Kaui, Pono, Koa, and Kai, for all the love and laughter —P. D. Editor in Chief: Donna Battista Acquisitions Editor: Katie Rowland Executive Development Editor: Rebecca Ferris-Caruso Editorial Project Manager: Emily Biberger Managing Editor: Jeff Holcomb Senior Production Project Manager: Nancy Freihofer Senior Manufacturing Buyer: Carol Melville Cover Designer: Jonathan Boylan Cover Photo: Nikreates/Alamy Media Director: Susan Schoenberg Content Lead, MyFinanceLab: Miguel Leonarte Executive Media Producer: Melissa Honig Project Management and Text Design: Gillian Hall, The Aardvark Group Composition and Artwork: Laserwords Printer/Binder: R.R. Donnelley/Jefferson City Cover Printer: Lehigh Phoenix Text Font: Adobe Garamond Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on the appropriate page within text and on this copyright page. Credits: Cover: Sculpture in photo: Detail of Flamingo (1973), Alexander Calder. Installed in Federal Plaza, Chicago. Sheet metal and paint, 1615.4 x 1828.8 x......

Words: 129205 - Pages: 517

Premium Essay

Corporate Finance

...MSc Corporate Finance Dr. Kirak Kim Before we start Main branches of finance Corporate Finance How do we value projects and (optimally) finance them? Asset Pricing How do we price securities more precisely? What’s the difference? Is it a Corporate Finance question or an Asset Pricing question? □ You are the manager of Intel Corp. You are reviewing the proposal for the new plant to be built in China. The new plant requires a large onetime investment but will provide significant capacity addition as well as cost savings over the next 10 years. Should you approve the proposal for the new plant? □ “HSBC FTSE 100” is a index fund that replicates FTSE 100 index. The fund offers investors a convenient diversification at a low price. Would you be interested in investing in the fund (or somewhere else)? » What if it was TESCO that was considering HSBC FTSE 100 as an investment vehicle?  □ In 2004, Sergey Brin and Larry Page, the founders of Google Inc., were talking to investment bankers from Morgan Stanley. They hope to finance a number of potential opportunities through IPO (initial public offering). One of the most important concerns is of course what the offering price should be. Part 1 Project Valuation Dr. Kirak Kim MSc Corporate Finance EFiMM0017 Project Valuation  Investment decision  Revisit: Valuing unlevered cash flows  Revisit: Uncertainty and the notion of risk  Weighted average cost of capital  Adjusted present value Two......

Words: 8376 - Pages: 34

Premium Essay

Corporate Finance

...Corporate Finance Arguably, the role of a corporation's management is to increase the value of the firm to its shareholders while observing applicable laws and responsibilities. Corporate finance deals with the strategic financial issues associated with achieving this goal, such as how the corporation should raise and manage its capital, what investments the firm should make, what portion of profits should be returned to shareholders in the form of dividends, and whether it makes sense to merge with or acquire another firm. Balance Sheet Approach to Valuation If the role of management is to increase the shareholder value, then managers can make better decisions if they can predict the impact of those decisions on the firm's value. By observing the difference in the firm's equity value at different points in time, one can better evaluate the effectiveness of financial decisions. A rudimentary way of valuing the equity of a company is simply to take its balance sheet and subtract liabilities from assets to arrive at the equity value. However, this book value has little resemblance to the real value of the company. First, the assets are recorded at historical costs, which may be much greater than or much less their present market values. Second, assets such as patents, trademarks, loyal customers, and talented managers do not appear on the balance sheet but may have a significant impact on the firm's ability to generate future profits. So while the balance sheet method is......

Words: 15975 - Pages: 64

Premium Essay

Corporate Finance

...FINC 620 Corporate Finance Final Project FIN 620 Table of Contents I.                   An overview of the corporation II.                The latest financial statement III.             A summary of each financial statement IV.             Ratio calculation V.             Is the corporation’s stock a good buy or sell? VI.          Other information pertinent to the corporation that could affect its future performance and stock price VII.       Recommendation regarding the future of the corporation   I. Overview of Corporation For our final project I chose to study the automotive company Ford Motor company and to analyze their financials from 2006-2010 which was right before the massive economic recession. Ford was able to stay afloat during these rough years however this economic downturned caused one of largest competitors General Motors to receive billions of dollars in bailout money from the United States government. I chose to study Ford because I actually had started investing in their company in my own starting in 2006 and I wanted to study how Ford’s finances were positioned when I began investing and see if it was a great buy or I should have instead invested at the time in Toyota a large multi-national competitor that is based in Asia and also operate in the United States which I had thought about investing the money in back in 2006 however I choose Ford instead. “Mulally who was named president and CEO of Ford, in 2006, the famous American......

Words: 2667 - Pages: 11

Premium Essay

Corporate Finance

...TUTORIAL 1 BUSINESS PLANNING & FINANCIAL PLANNING 1. Candidate should explain that a stockholder owns part of a company and is entitled to income in the form of dividends. Stockholders also elect directors who run the company. Stakeholders are groups of people who have an interest in how the firm is run. These include stockholders, employees, management, creditors and customers among others. Each group is interested in the firm’s operation and profitability for its own reasons. All stockholders are stakeholders, but not all stakeholders are stockholders. 2. The two common sources of corporate financing are stocks (shares) and bonds. Shareholders are the owner of the firm in which they are entitled to dividend if firms generate profit. Bondholders are creditors to a firm. They receive fixed coupon payment (annually or semi-annually) until maturity of the bond plus principle at maturity. 3. Symmetric Information is a situation in which investors and managers have identical information about firms’ prospects. Asymmetric information is a situation in which managers have different (better) information about firms’ prospects than do investors. 4. The relationship between stockholders and the management is called the agency relationship. This occurs when the shareholders as principals hire their agents to act on their behalf. The possibility of conflicts of interest between them is termed as the agency problem. There are two types of agency costs, the direct costs originating from......

Words: 8052 - Pages: 33

Premium Essay

Corporate Finance

...Preface © The McGraw−Hill of Corporate Finance, Sixth Companies, 2002 Edition, Alternate Edition  COMPREHENSIVE TEACHING AND LEARNING PACKAGE xvi This edition of Fundamentals has more options than ever in terms of the textbook, instructor supplements, student supplements, and multimedia products. Mix and match to create a package that is perfect for your course! Textbook As with the previous edition, we are offering two versions of this text, both of which are packaged with an exciting student CD-ROM (see description under “Student Supplements”): • 0072469749 Standard Edition (22 Chapters) • 0072469870 Alternate Edition (26 Chapters) Instructor Supplements Annotated Instructor’s Edition (AIE) ISBN 0072469870 All your teaching resources are tied together here! This handy resource contains exten- sive references to the Instructor’s Manual regarding lecture tips, ethics notes, Internet references, international notes, and the availability of teaching PowerPoint slides. The lecture tips vary in content and purpose—providing an alternative perspective on a sub- ject, suggesting important points to be stressed, giving further examples, or recom- mending other readings. The ethics notes present background on topics that motivate classroom discussion of finance-related ethical issues. Other annotations include notes for the Real-World Tips, Concept Questions, Self-Test Problems, End-of-Chapter Prob- lems, Videos, references to the Cases in Finance text by Jim DeMello; and......

Words: 1125 - Pages: 5

Premium Essay

Corporate Finance

...An Overview of Corporate Finance and the Financial Environment In a beauty contest for companies, the winner is . . . General Electric. 11 Or at least General Electric is the most admired company in America, according to Fortune magazine’s annual survey. The other top ten finalists are Cisco Systems, WalMart Stores, Southwest Airlines, Microsoft, Home Depot, Berkshire Hathaway, Charles Schwab, Intel, and Dell Computer. What do these companies have that separates them from the rest of the pack? According to more than 4,000 executives, directors, and security analysts, these companies have the highest average scores across eight attributes: (1) innovativeness, (2) quality of management, (3) employee talent, (4) quality of products and services, (5) long-term investment value, (6) financial soundness, (7) social responsibility, and (8) use of corporate assets. These companies also have an incredible focus on using technology to reduce costs, to reduce inventory, and to speed up product delivery. For example, workers at Dell previously touched a computer 130 times during the assembly process but now touch it only 60 times. Using point-of-sale data, Wal-Mart is able to identify and meet surSee http://www.fortune. com for updates on the U.S. prising customer needs, such as bagels in Mexico, smoke detectors in Brazil, and house ranking. Fortune also ranks paint during the winter in Puerto Rico. Many of these companies are changing the way the Global Most Admired. business works...

Words: 351447 - Pages: 1406

Adj. -Ed/-Ing - 900 Words | energy economics - 1377 Words | Accepts Offers