L4 Real Options Flashcards
What are real options and what is the difference between finance options.
Is the right to make particular business decisions at a predetermined cost such as capital investment for a predetermined period of time.
Difference is that RO are not traded in competitive markets.
List 3 examples of Options
- Timing Option: delay an investment opportunity
- Expansion Option: grow or extend
- Learning Option: abandon or scale down and investment opportunity
When are real option valuations most useful?
(1) There is significant uncertainty surrounding expected value
(2) Projects can be staged
(3) Time and staging reveals new information
(4) Management can act on this information
NPV vs. Real Options
NPV: static/fixed, single forecast, determinalistic/limited tx of uncertainty, inflexible
Real Options: changing/dynamic/ probabilistic/more complete, flexible
What are the 3 methods to find Real Options
(1) Black Scholes
(2) Binomial Tree
(3) Simulation Analysis (NOT REQ.)
When do you use the Black Scholes Method?
When you value a derivative product and/or when there is only 1 material option.
When do you use the Binomial Tree Method?
On the majority
–> flexible, mutually exclusive options, staged investments, discrete time
What are the Factors affecting the timing of investment?
TVM is (+)
Volatility: waiting is most valuable when there is a large degree of uncertainty
Dividends: not optimal to exercise a call option early. Also always better to wait unless there is a cost in doing so.
