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22-1

CHAPTER

22

Options and Corporate


Finance: Basic
Concepts
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22-2

Chapter Outline
22.1 Options
22.2 Call Options
22.3 Put Options
22.4 Selling Options
22.5 Reading The Wall Street Journal
22.6 Combinations of Options
22.7 Valuing Options
22.8 An OptionPricing Formula
22.9 Stocks and Bonds as Options
22.10 Capital-Structure Policy and Options
22.11 Mergers and Options
22.12 Investment in Real Projects and Options
22.13 Summary and Conclusions
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22-3

22.1 Options
Many corporate securities are similar to the stock
options that are traded on organized exchanges.
Almost every issue of corporate stocks and bonds
has option features.
In addition, capital structure and capital
budgeting decisions can be viewed in terms of
options.
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22-4

22.1 Options Contracts:


Preliminaries
An option gives the holder the right, but not the obligation, to buy
or sell a given quantity of an asset on (or perhaps before) a given
date, at prices agreed upon today.
Calls versus Puts
Call options gives the holder the right, but not the obligation, to buy
a given quantity of some asset at some time in the future, at prices
agreed upon today. When exercising a call option, you call in the
asset.
Put options gives the holder the right, but not the obligation, to sell a
given quantity of an asset at some time in the future, at prices agreed
upon today. When exercising a put, you put the asset to someone.
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22-5

22.1 Options Contracts: Preliminaries


Exercising the Option
The act of buying or selling the underlying asset through the option contract.

Strike Price or Exercise Price


Refers to the fixed price in the option contract at which the holder can buy or sell
the underlying asset.

Expiry
The maturity date of the option is referred to as the expiration date, or the expiry.

European versus American options


European options can be exercised only at expiry.
American options can be exercised at any time up to expiry.

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22-6

Options Contracts: Preliminaries


In-the-Money
The exercise price is less than the spot price of the underlying
asset.

At-the-Money
The exercise price is equal to the spot price of the underlying
asset.

Out-of-the-Money
The exercise price is more than the spot price of the
underlying asset.
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22-7

Options Contracts: Preliminaries


Intrinsic Value
The difference between the exercise price of the
option and the spot price of the underlying asset.

Speculative Value
The difference between the option premium and the
intrinsic value of the option.

Option
Premium
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Intrinsic
Value

Speculative
+
Value

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22-8

22.2 Call Options


Call options gives the holder the right, but
not the obligation, to buy a given quantity
of some asset on or before some time in the
future, at prices agreed upon today.
When exercising a call option, you call in
the asset.

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22-9

Basic Call Option Pricing Relationships


at Expiry
At expiry, an American call option is worth the same as a
European option with the same characteristics.
If the call is in-the-money, it is worth ST E.
If the call is out-of-the-money, it is worthless:

C = Max[ST E, 0]
Where
ST is the value of the stock at expiry (time T)
E is the exercise price.
C is the value of the call option at expiry
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ac

al

Call Option Payoffs


Bu
y

Option payoffs ($)

60

40

20

20

40

50

60

80

100

120
Stock price ($)

20

40
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Exercise price = $50


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Call Option Payoffs


Option payoffs ($)

60

40

20

20

40

50

60

80

100

120
Stock price ($)

20

ll
ac

Exercise price = $50

Se

40

l
al

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Call Option Profits


Option payoffs ($)

60

Buy a call

40

20
10
20

40

50

60

10

80

100

120
Stock price ($)

20

40
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Exercise price = $50;


option premium = $10

Sell a call

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2213

22.3 Put Options


Put options gives the holder the right, but
not the obligation, to sell a given quantity of
an asset on or before some time in the
future, at prices agreed upon today.
When exercising a put, you put the asset
to someone.

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Basic Put Option Pricing Relationships


at Expiry
At expiry, an American put option is worth
the same as a European option with the
same characteristics.
If the put is in-the-money, it is worth E ST .
If the put is out-of-the-money, it is
worthless.
P = Max[E ST, 0]

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Put Option Payoffs


Option payoffs ($)

60
50
40

20

20

40

50

60

80

100

Buy a put
Stock price ($)

20

40
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Exercise price = $50


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Option payoffs ($)

Put Option Payoffs


40

20

Sell a put
0

20

40

50

60

80

100
Stock price ($)

20

40

Exercise price = $50

50
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Put Option Profits


Option payoffs ($)

60

40

20

Sell a put

10

10

20

40

50

60

80

100

Stock price ($)

Buy a put

20

40
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Exercise price = $50; option premium = $10


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The seller (or writer) of an option has an obligation.


The purchaser of an option has an option.
40

Buy a call
y
Bu
ap
ut

Option payoffs ($)

22.4 Selling Options

10

10

Sell a call

Buy a call

ll
e
S

Sell a put
40

50 60

100

Stock price ($)


Buy a put

ut
p
a

40
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Exercise price = $50;


option premium = $10

Sell a call

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2219

22.5 Reading The Wall


Street Journal
Option/Strike Exp.
IBM
130 Oct
138
130 Jan
138
135 Jul
138
135 Aug
138
140 Jul
138
140 Aug

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--Call---Put-Vol. Last Vol. Last


364 15
107
5
112 19
420
9
2365
4 2431 13/16
1231
9
94
5
1826
1
427
2
2193
6
58
7

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2220

22.5 Reading The Wall Street Journal


This option has a strike price of $135;

Option/Strike Exp.
IBM
130 Oct
138
130 Jan
138
135 Jul
138
135 Aug
138
140 Jul
138
140 Aug

--Call---Put-Vol. Last Vol. Last


364 15
107
5
112 19
420
9
2365
4 2431 13/16
1231
9
94
5
1826
1
427
2
2193
6
58
7

a recent price for the stock is $138.25


July is the expiration month
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2221

22.5 Reading The Wall Street Journal


This makes a call option with this exercise price in-themoney by $3.25 = $138 $135.

Option/Strike Exp.
IBM
130 Oct
138
130 Jan
138
135 Jul
138
135 Aug
138
140 Jul
138
140 Aug

--Call---Put-Vol. Last Vol. Last


364 15
107
5
112 19
420
9
2365
4 2431 13/16
1231
9
94
5
1826
1
427
2
2193
6
58
7

Puts with this exercise price are out-of-the-money.


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2222

22.5 Reading The Wall Street Journal


Option/Strike Exp.
IBM
130 Oct
138
130 Jan
138
135 Jul
138
135 Aug
138
140 Jul
138
140 Aug

--Call---Put-Vol. Last Vol. Last


364 15
107
5
112 19
420
9
2365
4 2431 13/16
1231
9
94
5
1826
1
427
2
2193
6
58
7

On this day, 2,365 call options with this


exercise price were traded.
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22.5 Reading The Wall Street Journal


The CALL option with a strike price
of $135 is trading for $4.75.

--Call---Put-Option/Strike Exp. Vol. Last Vol. Last


IBM
130 Oct
364 15
107
5
138
130 Jan
112 19
420
9
138
135 Jul
2365
4 2431 13/16
138
135 Aug 1231
9
94
5
138
140 Jul
1826
1
427
2
138
140 Aug 2193
6
58
7
Since the option is on 100 shares of stock, buying
this option would cost $475 plus commissions.
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22.5 Reading The Wall Street Journal


--Call---Put-Option/Strike Exp. Vol. Last Vol. Last
IBM
130 Oct
364 15
107
5
138
130 Jan
112 19
420
9
138
135 Jul
2365
4 2431 13/16
138
135 Aug 1231
9
94
5
138
140 Jul
1826
1
427
2
138
140 Aug 2193
6
58
7
On this day, 2,431 put options with this
exercise price were traded.

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2225

22.5 Reading The Wall Street Journal


The PUT option with a strike price of $135 is
trading for $.8125.

--Call---Put-Option/Strike Exp. Vol. Last Vol. Last


IBM
130 Oct
364 15
107
5
138
130 Jan
112 19
420
9
138
135 Jul
2365
4 2431 13/16
138
135 Aug 1231
9
94
5
138
140 Jul
1826
1
427
2
138
140 Aug 2193
6
58
7
Since the option is on 100 shares of stock, buying
this option would cost $81.25 plus commissions.
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22.6 Combinations of Options


Puts and calls can serve as the building
blocks for more complex option contracts.
If you understand this, you can become a
financial engineer, tailoring the risk-return
profile to meet your clients needs.

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Protective Put Strategy: Buy a Put and Buy


the Underlying Stock: Payoffs at Expiry
Value at
expiry

Protective Put payoffs

$50
Buy the
stock

Buy a put with an exercise


price of $50

$0
$50
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Value of
stock at
expiry
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2228

Protective Put Strategy Profits


Value at
expiry

Buy the stock at $40

$40

Protective Put
strategy has
downside protection
and upside potential

$0
-$10

-$40
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$40 $50

Buy a put with exercise price of $50


for $10
Value of
stock at
expiry
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2229

Covered Call Strategy


Value at
expiry

Buy the stock at $40

$10

Covered Call strategy

$0

Value of stock at expiry


$40 $50

-$30

Sell a call with exercise price


of $50 for $10

-$40
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Option payoffs ($)

Long Straddle: Buy a Call and a Put


Buy a call with exercise
price of $50 for $10

40
30

30
20

40

60

Stock price ($)


70

Buy a put with exercise


price of $50 for $10

$50
A Long Straddle only makes money if the stock price moves
$20 away from $50.
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Option payoffs ($)

Long Straddle: Buy a Call and a Put


This Short Straddle only loses money if the stock
price moves $20 away from $50.

20

Sell a put with exercise price of


$50 for $10
30

30
40
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40

$50

60

70

Stock price ($)

Sell a call with an


exercise price of $50 for $10
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Put-Call Parity: p0 + S0 = c0 + E/(1+ r)T

Option payoffs ($)

Portfolio value today = c0 +

E
(1+ r)T

Portfolio payoff

Call

bond

25

25

Stock price ($)

Consider the payoffs from holding a portfolio


consisting of a call with a strike price of $25 and a
bond with a future value of $25.
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Put-Call Parity: p0 + S0 = c0 + E/(1+ r)T

Option payoffs ($)

Portfolio value today = p0 + S0

Portfolio payoff

25

Stock price ($)


25

Consider the payoffs from holding a portfolio


consisting of a share of stock and a put with a $25
strike.

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Put-Call Parity: p0 + S0 = c0 + E/(1+ r)T


Portfolio value today
E
= c0 +
(1+ r)T

Option payoffs ($)

Option payoffs ($)

2234

25

Portfolio value today


= p0 + S0

25

25

Stock price ($)

25

Stock price ($)

Since these portfolios have identical payoffs, they must have the same
value today: hence
Put-Call Parity: c0 + E/(1+r)T = p0 + S0
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22.7 Valuing Options


The last section
concerned itself with
the value of an option
at expiry.

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This section considers


the value of an option
prior to the expiration
date.
A much more
interesting question.

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2236

Option Value Determinants


1.
2.
3.
4.
5.

Stock price
Exercise price
Interest rate
Volatility in the stock price
Expiration date

Call
+

+
+
+

Put

+
+

The value of a call option C0 must fall within


max (S0 E, 0) < C0 < S0.
The precise position will depend on these factors.
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Market Value, Time Value and Intrinsic Value


for an American Call
ST

Option payoffs ($)

Profit

25

Call

Market Value
Time value
Intrinsic value

ST

E
Out-of-the-money
loss

In-the-money

The value of a call option C0 must fall within max (S0 E, 0) < C0 < S0.

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22.8 An OptionPricing Formula


We will start with a
binomial option
pricing formula to
build our intuition.

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Then we will
graduate to the
normal
approximation to
the binomial for
some real-world
option valuation.
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2239

Binomial Option Pricing Model

Suppose a stock is worth $25 today and in one period will either be
worth 15% more or 15% less. S0= $25 today and in one year S1is
either $28.75 or $21.25. The risk-free rate is 5%. What is the
value of an at-the-money call option?

S0

S1

$28.75 = $25(1.15)

$25
$21.25 = $25(1 .15)
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Binomial Option Pricing Model

1. A call option on this stock with exercise price of $25 will have

the following payoffs.


2. We can replicate the payoffs of the call option. With a levered
position in the stock.

S0

S1

C1

$28.75

$3.75

$21.25

$0

$25

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Binomial Option Pricing Model

Borrow the present value of $21.25 today and buy 1 share.


The net payoff for this levered equity portfolio in one period is either
$7.50 or $0.
The levered equity portfolio has twice the options payoff so the
portfolio is worth twice the call option value.

S0

( S1 debt ) = portfolio C1

$28.75 $21.25 = $7.50

$3.75

$25
$21.25 $21.25 =
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$0

$0

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Binomial Option Pricing Model


The value today of the levered equity portfolio is
todays value of one share less the present value
$21.25
of a $21.25 debt:
$25
(1 rf )
S0

( S1 debt ) = portfolio C1

$28.75 $21.25 = $7.50

$3.75

$25
$21.25 $21.25 =
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$0

$0

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2243

Binomial Option Pricing Model

We can value the call option today


as half of the value of the
levered equity portfolio:

S0

1
$21.25
C0 $25
2
(1 r f )

( S1 debt ) = portfolio C1

$28.75 $21.25 = $7.50

$3.75

$25
$21.25 $21.25 =
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$0

$0

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2244

The Binomial Option Pricing Model

If the interest rate is 5%, the call is worth:


1
$21.25 1
$25 20.24 $2.38
C0 $25
2
(1.05) 2

C0

$2.38

S0

( S1 debt ) = portfolio C1

$28.75 $21.25 = $7.50

$3.75

$25
$21.25 $21.25 =

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$0

$0

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2245

Binomial Option Pricing Model


The most important lesson (so far) from the
binomial option pricing model is:

the replicating portfolio intuition.


Many derivative securities can be valued by
valuing portfolios of primitive securities
when those portfolios have the same
payoffs as the derivative securities.
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Delta and the Hedge Ratio


This practice of the construction of a
riskless hedge is called delta hedging.
The delta of a call option is positive.
Recall from the example:
$3.75 0
$3.75 1
Swing of call

Swing of stock
$28.75 $21.25 $7.5 2
The delta of a put option is negative.

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Delta
Determining the Amount of Borrowing:
1
$21.25 1
$25 $20.24 $2.38
C0 $25
2
(1.05) 2

Value of a call = Stock price Delta Amount


borrowed
$2.38 = $25 Amount borrowed
Amount borrowed = $10.12
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2248

The Risk-Neutral Approach to Valuation


S(U), V(U)
q

S(0), V(0)
1- q

S(D), V(D)

We could value V(0) as the value of the replicating


portfolio. An equivalent method is risk-neutral
valuation


V (0)

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q V (U ) (1 q) V ( D)
(1 rf )

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2249

The Risk-Neutral Approach to Valuation


S(U), V(U)
q
q is the risk-neutral
probability of an
up move.

S(0), V(0)
S(0) is the value of the
underlying asset today.

1- q

S(D), V(D)

S(U) and S(D) are the values of the asset in


the next period following an up move and a
down move, respectively.
V(U) and V(D) are the values of the asset in the next period
following an up move and a down move, respectively.
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The Risk-Neutral Approach to Valuation


S(U), V(U)
q

V (0)

S(0), V(0)

q V (U ) (1 q) V ( D)
(1 rf )

1- q
S(D), V(D)

The key to finding q is to note that it is already impounded into


an observable security price: the value of S(0):
q S (U ) (1 q) S ( D)
S (0)
(1 rf )

A minor bit of algebra yields: q


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(1 rf ) S (0) S ( D )
S (U ) S ( D )

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2251

Example of the Risk-Neutral Valuation of a Call:


Suppose a stock is worth $25 today and in one period will
either be worth 15% more or 15% less. The risk-free rate is
5%. What is the value of an at-the-money call option?
The binomial tree would look like this:
$28.75 $25 (1.15)

$25,C(0)

$21.25 $25 (1 .15)

1- q
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$28.75,C(D)

$21.25,C(D)
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2252

Example of the Risk-Neutral Valuation of a Call:


The next step would be to compute the risk neutral probabilities
q

(1 rf ) S (0) S ( D)
S (U ) S ( D)

(1.05) $25 $21.25


$5

2 3
q
$28.75 $21.25
$7.50

2/3

$28.75,C(D)

$25,C(0)
1/3
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$21.25,C(D)
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2253

Example of the Risk-Neutral Valuation of a Call:


After that, find the value of the call in the up state and
down state.
C (U ) $28.75 $25

2/3

$25,C(0)

C ( D) max[$25 $28.75,0]

1/3

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$28.75, $3.75

$21.25, $0

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2254

Example of the Risk-Neutral Valuation of a Call:


Finally, find the value of the call at time 0:
q C (U ) (1 q) C ( D)
C (0)
(1 rf )
C (0)
C (0)

2 3 $3.75 (1 3) $0
(1.05)

$2.50
$2.38
(1.05)

2/3

$28.75,$3.75

$25,$2.38
$25,C(0)
1/3
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$21.25, $0

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2255

Risk-Neutral Valuation
and the Replicating Portfolio

This risk-neutral result is consistent with


valuing the call using a replicating portfolio.
2 3 $3.75 (1 3) $0 $2.50
C0

$2.38
(1.05)
1.05
1
$21.25 1
$25 20.24 $2.38
C0 $25
2
(1.05) 2
McGraw-Hill/Irwin
Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2256

The Black-Scholes Model

The Black-Scholes Model is


rT

Where C0 S N(d1 ) Ee N(d2 )

C0 = the value of a European option at time t = 0


r = the risk-free interest rate.
2

ln(S / E ) (r )T
2
d1
T

N(d) = Probability that a


standardized, normally
distributed, random
variable will be less than
d2 d1 T
or equal to d.
The Black-Scholes Model allows us to value options in the
real world just as we have done in the 2-state world.
McGraw-Hill/Irwin
Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2257

The Black-Scholes Model

Find the value of a six-month call option on the Microsoft


with an exercise price of $150
The current value of a share of Microsoft is $160
The interest rate available in the U.S. is r = 5%.
The option maturity is 6 months (half of a year).
The volatility of the underlying asset is 30% per annum.
Before we start, note that the intrinsic value of the option
is $10our answer must be at least that amount.
McGraw-Hill/Irwin
Corporate Finance, 7/e

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2258

The Black-Scholes Model

Lets try our hand at using the model. If you have a


calculator handy, follow along.
First calculate d1 and d2
(r .5 2 )T
ln(
S
/
E
)
d1
T
(.05 .5(0.30)2 ).5
ln(
160
/
150
)
0.5282
d1
0.30 .5
Then,
d2 d1 T 0.52815 0.30 .5 0.31602
McGraw-Hill/Irwin
Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2259

The Black-Scholes Model


rT

C0 S N(d1 ) Ee N(d2 )

d1 0.5282
d2 0.31602

N(d1) = N(0.52815) = 0.7013


N(d2) = N(0.31602) = 0.62401

C0 $160 0.7013 150e


C0 $20.92

McGraw-Hill/Irwin
Corporate Finance, 7/e

.05 .5

0. 62401

2005 The McGraw-Hill Companies, Inc. All Rights

2261

22.9 Stocks and Bonds as Options


Levered Equity is a Call Option.
The underlying asset comprise the assets of the firm.
The strike price is the payoff of the bond.

If at the maturity of their debt, the assets of the firm are


greater in value than the debt, the shareholders have an
in-the-money call, they will pay the bondholders and
call in the assets of the firm.
If at the maturity of the debt the shareholders have an
out-of-the-money call, they will not pay the bondholders
(i.e. the shareholders will declare bankruptcy) and let the
call expire.
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Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2262

22.9 Stocks and Bonds as Options


Levered Equity is a Put Option.
The underlying asset comprise the assets of the firm.
The strike price is the payoff of the bond.

If at the maturity of their debt, the assets of the firm are


less in value than the debt, shareholders have an in-themoney put.
They will put the firm to the bondholders.
If at the maturity of the debt the shareholders have an
out-of-the-money put, they will not exercise the option
(i.e. NOT declare bankruptcy) and let the put expire.
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Corporate Finance, 7/e

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2263

22.9 Stocks and Bonds as Options


It all comes down to put-call parity.
E
c0 = S0 + p0
(1+ r)T
Value of a
call on the
firm

Value of a
Value of
= the firm + put on the
firm

Stockholders
position in terms
of call options
McGraw-Hill/Irwin
Corporate Finance, 7/e

Value of a
risk-free
bond

Stockholders
position in terms
of put options
2005 The McGraw-Hill Companies, Inc. All Rights

2264

22.10 Capital-Structure Policy


and Options
Recall some of the agency costs of debt:
they can all be seen in terms of options.
For example, recall the incentive
shareholders in a levered firm have to take
large risks.

McGraw-Hill/Irwin
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2265

Balance Sheet for a Company


in Distress

Assets
Cash
Fixed Asset
Total

BVMVLiabilities
$200$200LT bonds
$400$0Equity $300
$600$200Total $600

BVMV
$300
$200

$200
$0

What happens if the firm is liquidated today?

The bondholders get $200; the shareholders get nothing.

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2266

Selfish Strategy 1: Take Large Risks

The Gamble
Win Big
Lose Big

Probability
10%
90%

Payoff
$1,000
$0

Cost of investment is $200 (all the firms cash)


Required return is 50%
Expected CF from the Gamble = $1000 0.10 + $0 = $100

$100
NPV = $200 +
(1.10)
NPV = $133
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2267

Selfish Stockholders Accept Negative NPV


Project with Large Risks
Expected CF from the Gamble
To Bondholders = $300 0.10 + $0 = $30
To Stockholders = ($1000 $300) 0.10 + $0 = $70

PV of Bonds Without the Gamble = $200


PV of Stocks Without the Gamble = $0

$30
PV of Bonds With the Gamble: $20 =
(1.50)
$70
PV of Stocks With the Gamble: $47 =
(1.50)

The stocks are worth more with the high risk project because the call
option that the shareholders of the levered firm hold is worth more when
the volatility of the firm is increased.
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2268

22.11 Mergers and Options


This is an area rich with optionality, both in the
structuring of the deals and in their execution.
In the first half of 2000, General Mills was
attempting to acquire the Pillsbury division of
Diageo PLC.
The structure of the deal was Diageos
stockholders received 141 million shares of
General Mills stock (then valued at $42.55) plus
contingent value rights of $4.55 per share.

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Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2269

22.11 Mergers and Options

Cash
payment to
newly
issued
shares

The contingent value rights paid


the difference between $42.55 and
General Mills stock price in one
year up to a maximum of $4.55.

$4.55
$0
$38 $42.55

McGraw-Hill/Irwin
Corporate Finance, 7/e

Value of General
Mills in 1 year

2005 The McGraw-Hill Companies, Inc. All Rights

2270

22.11 Mergers and Options


The contingent value plan can be viewed in
terms of puts:
Each newly issued share of General Mills
given to Diageos shareholders came with a
put option with an exercise price of $42.55.
But the shareholders of Diageo sold a put with
an exercise price of $38

McGraw-Hill/Irwin
Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2271

22.11 Mergers and Options

Cash payment to newly issued shares


Own a put
Strike $42.55
$42.55

$42.55
$38.00
$4.55
$0
$38 $42.55

$38
McGraw-Hill/Irwin
Corporate Finance, 7/e

Value of General
Mills in 1 year

Sell a put
Strike $38
2005 The McGraw-Hill Companies, Inc. All Rights

2272

22.11 Mergers and Options


Value of
General
Mills in 1
year

Value of a share
plus cash
payment

Value of a share

$42.55

$4.55
$0
$38 $42.55
McGraw-Hill/Irwin
Corporate Finance, 7/e

Value of General
Mills in 1 year

2005 The McGraw-Hill Companies, Inc. All Rights

2273

22.12 Investment in Real Projects & Options


Classic NPV calculations typically ignore
the flexibility that real-world firms typically
have.
The next chapter will take up this point.

McGraw-Hill/Irwin
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2274

22.13 Summary and Conclusions


The most familiar options are puts and calls.
Put options give the holder the right to sell stock at a
set price for a given amount of time.
Call options give the holder the right to buy stock at a
set price for a given amount of time.

Put-Call parity

E
c0
T = S0 + p0
(1+ r)
McGraw-Hill/Irwin
Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights

2275

22.13 Summary and Conclusions


The value of a stock option depends on six factors:
1. Current price of underlying stock.
2. Dividend yield of the underlying stock.
3. Strike price specified in the option contract.
4. Risk-free interest rate over the life of the contract.
5. Time remaining until the option contract expires.
6. Price volatility of the underlying stock.

Much of corporate financial theory can be presented in


terms of options.
1.
2.

Common stock in a levered firm can be viewed as a call option on the


assets of the firm.
Real projects often have hidden option that enhance value.

McGraw-Hill/Irwin
Corporate Finance, 7/e

2005 The McGraw-Hill Companies, Inc. All Rights