Financial Derivatives:

Arundel Partners: The Sequel Project

Boris Agababov
Ekaterina Kouznetsova
Alexander Nagornov
Alexander Parkhomenk
 Introduction of Arundel Sequel Project

Innovative idea: purchase sequel rights for

films produced by one or more major U.S.
movie studios

• Purchase sequel rights before the first

films are even made
• Arundel does not make artistic judgments
or select the rights for particular movies
based on predictions for possible success
• Advance cash payments for the rights at
a pre- agreed price to help finance
production of the initial film
How does Arundel expect to benefit from the idea

• Arundel can exercise the right when the

performance of the first film is known.
Expect revenue: 70% of the original movie
• If expected profitability is low or costs
are too high to produce sequel Arundel
can sell the right to the highest bidder.
• The loss a no moviegoer sequel will
be: “price they sold the right – price they
paid for the right” :
loss will be deductible from tax.
• Arundel expects that gains from
successful sequels will offset the losses
 When does Arundel buy the rights?

The sequel rights are purchased before

production of first movie:
• Purchase sequel rights for entire
production of studio
• Unknown which movies are going to be
produced at the moment Arundel
purchases sequel rights.
• Price and number of movies should be
agreed before either parties know which films
are going to be produced.
• Arundel don’t want to pay prices which
reflects the opinion of the studio about the
movie
•
 How much are the sequel rights worth in 1989?
Assumptions

• We assume that the company buys sequel

rights for the full sample portfolio (exhibit 6,
a sample of 99 films)
• The option is exercised when present
value of cash inflows is higher than USD 27,7
mln (mean of the sample)
• If a sequel is produced, it is expected to
generate 70% of the revenues of the
original film.
• The negative cost of a sequel is expected
to be 120% of the negative cost of original
film
•
How much are the sequel rights worth in 1989?
Calculations

Maximum price of the option should be such that Arundel

generates 0 gain. Estimated price of an option – maximum
How much are the sequel rights worth in 1989?
Sensitivity Analysis
 Application of Black- Scholes Model

• Call price C = SN ( d1 ) − Ke − rT N ( d 2 )

S 
ln  
d1 =   + 0.5σ T
K
d 2 = d1 − σ T
σ T

• Parameters
– S = current value of underlying = expected Revenue of a Sequel discounted to t=0
– K = strike price = expected Cost of a Sequel (which has to be covered by revenue)
– T = time-to-maturity (in Periods)
σ = standard deviation of ∆ S/S (S0 = avg, S1 = exp. revenue after first film)
– r = risk adjusted rate (here per Period)
– N(z) =cumulative standard normal probability density from -∞ to z
Estimation of parameters for Black-Scholes

PV of cash
Studio/Movie Title n
inflows

years 1
MCA Universal
PARENTHOOD 100.1
BORN ON THE FOURTH OF JULY 74.5
FIELD OF DREAMS 59.1
UNCLE BUCK 60.0
SEA OF LOVE 53.5
ALWAYS 34.3
Estimation Results of Black-Scholes
 Why Black-Scholes is not working?

• Markets are efficient

• Returns are normally distributed
Thank you for your attention!