28.1 Chapter 28 Real options Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 28.1 Chapter 28 Real Options
28.2 An alternative to the npv rule for Capital Investments Define stochastic processes for the key underlying variables and use risk- neutral valuation This approach(known as the real options approach) is likely to do a better job at valuing growth options, abandonment options, etc than NPV Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 28.2 An Alternative to the NPV Rule for Capital Investments • Define stochastic processes for the key underlying variables and use riskneutral valuation • This approach (known as the real options approach) is likely to do a better job at valuing growth options, abandonment options, etc than NPV
28.3 The Problem with using NPV to Value options Consider the example from Chapter 10 Stock Price $22 Stock price $20 Stock Price=$18 Suppose that the expected return required by investors in the real world on the stock is 16%. What discount rate should we use to value an option with strike price $21? Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 28.3 The Problem with using NPV to Value Options • Consider the example from Chapter 10 • Suppose that the expected return required by investors in the real world on the stock is 16%. What discount rate should we use to value an option with strike price $21? Stock Price = $22 Stock price = $20 Stock Price=$18
28.4 Correct Discount Rates are Counter-Intuitive Correct discount rate for a call option is 42.6% Correct discount rate for a put option is 52.5% Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 28.4 Correct Discount Rates are Counter-Intuitive • Correct discount rate for a call option is 42.6% • Correct discount rate for a put option is –52.5%
28.5 General Approach to valuation We can value any asset dependent on a variable e by Reducing the expected growth rate of e by ns where n is the market price of e-risk and s is the volatility of 0 Assuming that all investors are risk-neutral Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 28.5 General Approach to Valuation • We can value any asset dependent on a variable q by – Reducing the expected growth rate of q by ls where l is the market price of q-risk and s is the volatility of q – Assuming that all investors are risk-neutral