1. The value of a security is the sum of its constituent pieces.
Identify all the pieces, and you can begin to value anything! The
most frequent and serious errors in valuation analysis is to ignore the
hidden options. Hidden options in this case were:
- long call option on stock (conversion option).
- short call option on interest rates (redemption option).
- long put option on change-of-control (poison put).
2. The pieces are not easy to value. That’s why we have Financial
Engineers. They do the heavy lifting. However, you MUST be
able to describe to them the structural features of the options (e.g.,
underlying asset, exercise price, term, volatility).
For example, in convertible bonds, the redemption is nearly always
used to force investors to convert to shares--thus it may be considered
an option to shorten the life of the bond. This reduces the value
of the conversion option. You can see how severe this may be by valuing
the conversion option over 3, 4, or 5 years. The appropriateness
of Boston convert’s value is a bet on growth.
3. This stuff does not give clear simple answers. Learn this stuff because
it gets us closer to truth than anything else. It gives us a way
to think about the problem that is very powerful.
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Click on Case Data below to go to selected case data in Excel format.
This will save you time in data entry.
We do a lot of cases this quarter that contain massive amounts of financial
data.
Case Data
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To get an Excel program that calculates the value of an option based
on the Black-Scholes option-pricing model click below.
B-S option pricing model in Excel format.
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Syllabus in Word format (Office
98) This will download and open on your machine.
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