Week 10 Real options Flashcards
What is shiller’s Definition of a bubble?
- Investor enthusiasm spread via stories that justify a price
What causes a bubble?
Caused by irrational investing decisions and fear of missing out
Are bubbles rational or irrational?
Both
Rational view
- investors are placing high valuations to capitalise on the firm’s options in the future
(acting like call options)
Irrational view
- “noise investors” following the crowd to try capitalise on rising prices
What is a unicorn?
What causes a unicorn?
Privately held start up with a valuation of 1b
Caused by:
- Winner takes all attitude of tech industry
- High valuations are usually caused by a single investor’s latest contribution that devalues all shares above 1b
What are the three points to evaluate when trying to “know” a firm?
- Role of stories
- Real options value of investment
- Different kinds of real options
What is the importance of a story to a growth stock?
- They share their vision to try open the eyes to investors to their growth options
- growth options are not accounted for in standard DCF models
What are options?
-Provide flexibility to undertake a course of action contingent on particular outcomes
What is a call option?
The right to buy an asset as a specific exercise price on or before a specific expiry date
The riskier the company, higher value call options
What is a put option?
The right to sell an asset at a specific exercise price on or before a specific expiry date
What is the contrast between high valuations and call options?
High valuations that are not justified by cashflows can be viewed like a call option for the company
Expiry date: infinite
What are the factors determining an options value?
- underlying asset value
- Exercise price
- Volatility
- Time to maturity
- Risk free rate
How does an increase in each factor affect a call options value?
Underlying asset value= Increase
Exercise price = decrease
Volatility = increase
Time to maturity = increase
Risk free rate = increase
How does an increase in each factor affect a put options value?
Underlying asset value= decrease
Exercise price = increase
Volatility = increase
Time to maturity = increase
Risk free rate = increase
What are Financial options?
The right to sell or buy a security at a given price at a given time in the future
What is a real option?
The right to be flexible in ones future decisions regarding risky investments
