...Managerial Finance | Use of Real Options Theory in Financial Management/Modeling | Tiffany Allen | BUS 650 | Prof. Achilles | 11/14/2011 | | Abstract In business, as in life, you always have options to choose from. In today's extremely unstable market, managers realize how incredibly risky some investment opportunities can be, and how useful a flexible strategy can be. Using real options theory, managers can more effectively analyze opportunities to pursue, delay, modify, or abandon projects as events unfold. This paper analyzes the use of real option theory in financial management and modeling. It discusses issues included in the implementation of the theory in financial management and modeling. It explains new learning in real option theory and a case study that was able to apply the theory along with the application of the theory to my current business which has helped me understand real option theory. Use of Real Options Theory in Financial Management/Modeling The Real Option Theory has struck some interest with managers in the last couple of decades. Back in the day, companies had plenty of time to make decisions to make changes when they felt it was necessary. Now, if they take their time deciding on changes, chances are by the time they finally make a decision, another company has already made the move. Times have change and especially with how the economy is today, it’s a “Dog Eat Dog World” and in this competitive market, you...
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...Options Theory Applied to Alternative Energy Industry Christina Clowdus Bus: 630 March 20, 2012 Dr. Shaw Introduction In life, you always have options. It is no different in capital investment. In today's unpredictable business world, managers recognize how risky the most valuable investment opportunities often are, and how useful a flexible strategy can be. That's why they want to know all their options. Yet many current financial assessment tools fail to identify what investors can do to capitalize on future uncertain events. “Managerial flexibility to adapt and revise future decisions in order to capitalize on favorable future opportunities or to limit losses has proven vital to long-term corporate success in an uncertain and changing marketplace” (Brennan, M.J. and E.S. Schwartz 1985, p. 15). Utilizing a real options strategy allows businesses to capture the value of managerial flexibility in adapting decisions in response to unexpected market developments. When used as a conceptual tool, real options allow management to characterize and communicate the strategic value of an investment project (Bjerksund, P. and S. Ekern 1990). Traditional methods (e.g. net present value, discounted cash flow) fail to accurately capture the economic value of investments in an environment of widespread uncertainty and rapid change. Using real options theory, managers can more effectively target crucial opportunities to redeploy, delay, modify, or even abandon capital-intensive projects...
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...its fundamental importance, the PMBOK should be critically reviewed. This paper agues for an expansion of the PMBOK Guide's risk management knowledge area to include a wider perspective of incomplete knowledge. The PMBOK Guide deals with uncertainty through the traditional use of probability theory, however the underpinning assumptions of probability theory do not always apply in practice. Furthermore, probability-based risk management theory does not explain important aspects of observed project management practice. This paper discusses an expanded framework of incomplete knowledge, including: an expanded concept of uncertainty that acknowledges ignorance or surprise, where there is no prior knowledge of future states; imprecision arising from ambiguity (fuzziness) in project parameters and future states; and, human limitations in information processing. The paper shows the expanded framework explains observed project-management practice more thoroughly than the probability-based framework. The conclusion reached is that ``management of incomplete knowledge'' provides a better theoretical foundation for improving project management practice. To substantiate this, a promising new approach based on ``real options'' is also discussed. # 2001 Elsevier Science Ltd and IPMA. All...
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...EBMA Level 8 Diploma in strategic Business Research and Leadership Direction Unit Title: Strategic Financial Analysis and Planning Table of Contents Executive Summary 3 1.Critique and evaluate research ....... 4 2.Critically apply modern financial tools 6 3.Use main types of investment appraisal tools 8 4.Critically evaluate the importance of research 10 References 11 Executive Summary The decision making of management is very crucial and involves various analysis to be performed. There are various ratios and methods that can be useful for mitigating the risks and increasing the expected returns with investments. The financial forecast is a mix of the behaviour, perception of management alongwith various techniques used for analysis of the different options available. Critique and evaluate research in financial theory and apply that research for decision making process 1.1 Describe the economic theory of choice as an illustration under certainty. The rational behind the economic theory of choice is to choose out of certain economic outcomes and representing the preferences through maximisation of the utility function of the outcomes. As per the von Neumann-Morgenstern expected utility model (1953), which is the workhorse of recent economics, the choices are made by people, so as to get the maximum utility. These preferences are based on intuition, self interest, past experiences etc...
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...Midterm Quiz 3410 Professor Smith Page 1 of 5 | Question 1 (1 point) Which political theory can be traced to the time period of the birth of Nazi "national socialist" fascism in 1928? Question 1 options: | Arabic Nationalism | | Islamo-Fascism | | Muslim Brotherhood | | Mohammeden Baskism | Save Question 2 (1 point) With the political theories,it is often the _______ which is the main cause of terrorism. Question 2 options: | frame of reference | | form of governance | | mission of the actors | | motivation of the elite | Save Question 3 (1 point) The phenomenon of terrorism is not difficult to define because it is intangible and fluctuates according to historical and geographical contexts. Question 3 options: | True | | False | Save Question 4 (1 point) Anarchism is a theory of governance that rejects any form of ________ authority. Question 4 options: | female or minority | | false or misleading | | central or external | | governmental | Save Question 5 (1 point) One of the main objectives of terrorism is usually to gain publicity for some cause. Question 5 options: | True | | False | Save Question 6 (1 point) According to _____, murder, especially murder-suicide, constitutes the highest form of revolutionary struggle. Question 6 options: | Johann Most | | Karl Marx | | Mihaly Csikszentmihalyi | | Albert Schweitzer | Save...
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...do CFOs make capital budgeting and capital structure decisions? Introduction A comprehensive survey is gone that describes the current practice of corporate finance. The survey will give us a betting understanding of where the theory and practice of corporate finance are consistent and areas where they are not. The survey conducted is based on two parts, capital budgeting and capital structure. The survey goes deeper and tries to find out what causes capital budgeting and structure decisions in firms. The survey consists of 100 questions to explore capital budgeting and structure decisions in depth. The original sample for the survey was 4,440 firms but only 392 CFOs responded to the survey, making the response rate a dramatic 9%. The results of the survey were analyzed based on firm characteristics. The responses given by the executives are compared in relation to the firm size, P/E ratio, leverage, credit rating, dividend policy, industry, management ownership, CEO age, CEO tenure, and CEO educational attainment. Comparing the responses to all these variables gives the results a more meaningful explanation because it is able to test various finance theories. The responses to the capital budgeting portion of the survey follow academic advice and use present value techniques to evaluate new projects. But when it comes to capital structure, firms rely on practical, informal rules and pay less attention to academic advice. Survey Methodology Before the surveys were sent out...
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...Journal of International Business Studies (2007) 38, 215–230 & 2007 Academy of International Business All rights reserved 0047-2506 $30.00 www.jibs.net Real options in multinational corporations: organizational challenges and risk implications Tony W Tong1 and Jeffrey J Reuer2 1 School of Management, State University of New York at Buffalo, Buffalo, NY, USA; 2Kenan-Flagler Business School, University of North Carolina, Chapel Hill, NC, USA Correspondence: JJ Reuer, Kenan-Flagler Business School, University of North Carolina, McColl Building, Chapel Hill, NC 27599, USA. Tel: þ 1 919 962 4514; Fax: þ 1 919 962 4266; E-mail: reuer@unc.edu Abstract In this study, we investigate how multinationality affects firms’ risk levels. Our investigation builds on the idea from real options theory that international operations offer switching options to multinational corporations, yet we also emphasize different sources of coordination costs that can mitigate the benefits of operational flexibility. The findings from Tobit models accounting for selfselection underscore the importance of unobserved heterogeneity in the relationships between international investments and risk levels. Consistent with the coordination costs surrounding international operations, we find that the relationship between multinationality and downside risk is curvilinear: risk first declines and then increases as a firm’s portfolio of international investments becomes extensive. In...
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...21, Solbjerg plads Background: ˚ – PhD in economics (Arhus) 1999 – System developer (Simcorp) 1999-2000 – Assisting/Associate Professor/Lecturer (CBS) 2000-2012 2 / 17 • Goal The overall goal • Practical implementation of financial theory How to get there? • Exercise-based (solving “real world” problems) • IT-based, everything based on Excel (and VBA) • Professional data source: Datastream Results • • • • Better understanding of (known) financial theory Better Excel-skills Better feeling with real world data All in all: Easier to get started (at your thesis/job) 3 / 17 1 Examples of skills after the course In half a work-day (or 4 hours exam :-) you will be able to solve one of these problems: • • • • Form a reasonable stock portfolio. Price an option, (Eur, Amr, Ber, Asian) Estimation of the term structure, (cubic spline). Predict the standard deviation of stock returns for next week, (basis for risk management). - You know the theories, but it will take you half a “term paper” to get an answer if you have not tried it before. 4 / 17 Structure of the Lessons 15 lessons (2 hours lecture and exercises) 14 has the following structure: 1. 2. 3. 4. E-lec: Review of last weeks exercise E-lec: Financial theory and Excel for next exercise You solve the exercises (guiding solution available) Physical lecture: Your questions / problems / Homepage... Very exercise based • Little reading, lots of “hands on” computer work • Exam on computers, (like...
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...Virgin Mobile USA: Pricing for the Very First Time Company Background Introduction Case Background Issue of Concern Market Research Analysis All Options Theory Application Calculation Virgin Response Conclusion Recommendations Inviting Questions 2 Introduction Analysis Conclusion Company Background • Virgin, a leading branded venture capital organization, is one of the world's most recognized and respected brands. • Conceived in 1970 by Sir Richard Branson, the Virgin Group has gone on to grow very successful business in sectors ranging from mobile telephony, to transportation, travel, financial services, leisure, music, holidays, publishing and retailing. • Virgin has created more than 200 branded companies worldwide, employing approximately 50,000 people, in 29 countries. Case Background Issue of Concern [Source: company website Available from: http://www.virgin.com/AboutVirgin/WhatWeAreAbout/WhatWeAreAbout.aspx] 3 Introduction Analysis Conclusion Company Background Case Background Issue of Concern 4 Introduction Analysis Conclusion Company Background Case Background Issue of Concern Sir Richard Charles Nicholas Branson (born 18 July 1950), is an English entrepreneur, best known for his Virgin brand, a banner that encompasses a variety of business organizations. The name Virgin was chosen because a female friend involved in setting down the initial record shop commented that there...
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...The Development of Modern Finance "A Short History of Value" David Roubaud & Jean-Charles Bagneris 10/2011 The Main Steps of the Theory Building • Portfolio Selection (Markowitz, 1952) • CAPM (Sharpe, 1963) • Financing and Dividend Decisions Neutrality (Modigliani et Miller, 1958, 1961,1963) • Efficient Markets (Fama, 1965, 1970) • Options Pricing Theory (Black & Scholes, 1973, Myers, 1977) • Agency Theory (Jensen, Meckling, 1976) • Efficient Markets II (Fama, 1991) • Behavioural Finance (Kahneman & Tversky, 1979, Shiller, 1981, 2000) Portfolio Selection • Investors are rationals and risk averse • Diversification lowers specific risk • Any portfolio is a combination of the market portfolio and the riskless asset The CAPM Capital Asset Pricing Model • Systematic risk of an asset is measured by its beta coefficient • The model calibrates the risk-return relationship • Simple, elegant and linear model => big success • Low explaining power (strong assumptions) • Alternative models are difficult to use 1 The Development of Modern Finance 2 Financial Markets Efficiency "At any given point in time, assets prices on financial markets account for all available information." • Strong assumptions on: – markets organization – investors behaviour • One consequence of EMH is Random Walk Hypothesis • Assumptions are not always true: 3 forms of efficiency (strong, semi-strong, weak) The irrelevance of financing and dividends decisions In a world without taxes and with perfect financial markets...
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...Option Trading Strategies and Their Effectiveness in the Indian Market The project starts with introduction to: * Overview of Derivatives and mainly Options. * The working and mechanics of options and how they help in hedging and trading. * History of Options with respect to Global & Indian Markets. * The advantages of Options The project mainly aims to cover the conceptual and theoretical background of the study including option terminology, option payoffs, payoff profiles of long & short underlying & long and short call and put options followed by options theory, knowledge and outline of the various possible trading and hedging strategies with options that are widely known including : * When to use the strategy * Basic legs involved * Other derivatives/underlying used with the strategy * The payoff profile of the strategy * The risk and reward * Breakeven points and profit and loss analysis Some of the strategies intended to be covered are: Long Call, Short Call, Synthetic Long Call, Long Put, Short Put, Covered Call, Straddles, Strangles, Collars, Spreads, Butterflies and Condors The various strategies are individually analysed with the help of detailed examples and then further studied taking real life examples of hypothetical positions from past data of Indian Derivatives market, mainly from the historical data archives of NSE as given on website of NSE. (Preferably recent month expiry contracts) Drawing of...
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...Explain how the option pricing formula developed by black and scholes can be used for common stock and bond valuation. Include in your discussion the consequences of using variance applied over the option instead of actual variance. Its generally known that Black and Scholes model became a standard in option pricing methods , with almost everything from corporate liabilities and debt instruments can be viewed as option (except some complicated instruments), we can modify the fundamental formula in order to fit the specifications of the instrument that will be valued. An argument done by Black and Scholes which was based on the past proposition of Miller and Modigliani a well as assuming some ideal conditions, States that value of the firm is a sum of total value of debt plus the total value of common stock. As well as the fact that in the absence of taxes, the value of the firm is independent of its leverage and the change of debt has no effect on the firm value. V = E + Dm V: value of the firm. E: shareholders right (common stock values). Dm: market value of the debt. As the above equation impose that Equity (common stock values) can be viewed as a call option on the firm value (due to the shareholders limited liability and with consideration that firm debt can be represent as a zero-coupon bond), where exercising the option means that equity holders buy the firm at the face value of debt (which is in this case will be the exercise price of the option), on the liquidation...
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...evaluate the paradox of markets v resources. Using real world examples, which side (if any) of the paradox seems to hold the most valid arguments? Paradox is a statement that is seen to be self contradictory or ridiculous but also has a possible truth (Dictinoary.com, 2014). Strategy is really important for a business as it gives them the long term direction of the company, the scope of their activities, helping them gain advantage of their competitors, tackling changes in the business environment, building on their resources and lastly meeting expectations of stakeholders. There are two key concepts to strategic management which help an organisation decide on their strategy. One of them is looking at the market and is known as the market view, it is really important to look at the external environment of a business to help make decisions as it will help highlight the threats and opportunities presented (Johnson et al., 2014). However, the external environment isn’t the only factor which has to be taken into consideration as another key concept is a resource based view; which looks at the internal environment of the business and their capabilities of resources and competences. Mangers of an organisation need to understand how the company is different from other competitors in the market in basis of ‘obtaining competitive advantage and superior performance’ (Johnson et al., 2014). There are many market view theories for companies to use like for example the PESTEL framework is used...
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...Duke University* e recently conducted a comprehensive survey that analyzed the current practice of corporate finance, with particular focus on the areas of capital budgeting and capital structure. The survey results enabled us to identify aspects of corporate practice that are consistent with finance theory, as well as aspects that are hard to reconcile with what we teach in our business schools today. In presenting these results, we hope that some practitioners will find it worthwhile to observe how other companies operate and perhaps modify their own practices. It may also be useful for finance academics to consider differences between theory and practice as a reason to revisit the theory. We solicited responses from approximately 4,440 companies and received 392 completed surveys, representing a wide variety of firms and industries.1 The survey contained nearly 100 questions and explored both capital budgeting and capital structure decisions in depth. The responses to these questions enabled us to explore whether and how these corporate policies are interrelated. For example, we investigated whether companies that made more aggressive use of debt financing also tended to use more sophisticated capital budgeting techniques, perhaps because of their greater need for discipline and precision in the corporate investment process. More generally, the design of our survey allowed for a richer understanding of corporate decision-making by analyzing the CFOs’ responses in the context...
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...Duke University* e recently conducted a comprehensive survey that analyzed the current practice of corporate finance, with particular focus on the areas of capital budgeting and capital structure. The survey results enabled us to identify aspects of corporate practice that are consistent with finance theory, as well as aspects that are hard to reconcile with what we teach in our business schools today. In presenting these results, we hope that some practitioners will find it worthwhile to observe how other companies operate and perhaps modify their own practices. It may also be useful for finance academics to consider differences between theory and practice as a reason to revisit the theory. We solicited responses from approximately 4,440 companies and received 392 completed surveys, representing a wide variety of firms and industries.1 The survey contained nearly 100 questions and explored both capital budgeting and capital structure decisions in depth. The responses to these questions enabled us to explore whether and how these corporate policies are interrelated. For example, we investigated whether companies that made more aggressive use of debt financing also tended to use more sophisticated capital budgeting techniques, perhaps because of their greater need for discipline and precision in the corporate investment process. More generally, the design of our survey allowed for a richer understanding of corporate decision-making by analyzing the CFOs’ responses in the context...
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