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Financial Engineering

The document discusses various types of options including call options, put options, European and American style options, in the money, out of the money, and at the money options. It also discusses call and put payoffs, long and short positions, exercise value vs market value, binomial and Black-Scholes models for calculating option value, and relationships among options including put-call parity. Additionally, it covers real options, agency theory, derivatives, and financial engineering.

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109 views14 pages

Financial Engineering

The document discusses various types of options including call options, put options, European and American style options, in the money, out of the money, and at the money options. It also discusses call and put payoffs, long and short positions, exercise value vs market value, binomial and Black-Scholes models for calculating option value, and relationships among options including put-call parity. Additionally, it covers real options, agency theory, derivatives, and financial engineering.

Uploaded by

truthoverlove
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Options, Agency, Derivatives and

Financial Engineering
Option Characteristics
 Options, like other securities, have value that is based
upon expectations of cash flows to occur in the future.
The characteristic that distinguishes options from
other securities is that options are contingent claims.
This means that the payoffs to an option depend upon
what happens to another value or cash flow, often of
another security or underlying assets.
Types of options
 A call option (sometimes simply called a “call") is a financial
contract between two parties, the seller (writer) and the buyer of
the option. The buyer has the right, but not obligation, to buy
the underlying instrument at an agreed-upon price (the strike
price).
 A put option (sometimes simply called a "put") is a financial
contract between two parties, the seller (writer) and the buyer of
the option. The buyer has the right, but not obligation, to sell the
underlying instrument at an agreed-upon price (the strike price).
 European vs American style options
 In the money
 Out of the money and
 At the money options
 Call and put payoffs – graphically and algebraically
 Long vs short positions
Call Options
Exercise value vs Market Value
Calculating the Value of a Simple Option
 Binomial Model – Discuss
 Assumes that at expiration only two outcomes of the price of the underlying
asset are possible.
 C0= YS0 + Z
Calculating the Value of a Simple
Option
Valuing More Realistic Options
 Black-Scholes Model
Relationships Among Options
 Put-Call Parity
1. A Fiduciary Call
a) Long a call
b) Long a riskless discount bond
C0 + X/ (1+R)T
2. Protective Put
a) Long a put
b) Long the underlying asset
P0 + S0
3. C0 + X/ (1+R)T = P0 + S0
Relationships Among Options
Real Options
 When an investment proposal carries with it an option
to alter, curtail or extend a project’s cash flows at some
future time, classic NPV is an inadequate evaluation
technique. This is because it cannot value embedded
options.
 Real options include the options to delay, abandon or
to expand.
 Discuss example on 12/28.
Agency
 An agent is an individual, group or organisation to
whom a principal has designated decision making
authority. In the context of the shareholder–
bondholder conflict, shareholders (or their
proxies, the financial managers) are the agents,
and the bondholders are the ‘principals’.
Principals are those who feel the ultimate effects
of the decisions taken by agents.
 In order for an agency situation to be a ‘problem’, it
must contain the potential for a conflict of interest
between principal and agent eg. Managers vs
shareholders.
Derivatives
 Discuss
 See list on page 12/39.
 Swaps
Financial Engineering
 Discuss

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