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Corporate Financial Management 3e
Emery Finnerty Stowe
Derivatives Applications
Learning Objectives
Describe four basic types of derivative securities.
Use the Black–Scholes option pricing model (BS–OPM) to value call and put options mon stock, and also to value warrants.
Explain how a firm can force conversion of its outstanding convertible securities.
Explain how a firm can use derivatives to hedge specific risks.
Chapter Outline
Options
Option Pricing Models
Warrants
Convertible Securities
Swaps
Forwards and Futures
Hedging
Derivatives Applications and the Principles of Finance
Valuable Ideas
Look for ideas to manage firm risk.
Options
Recognize the value of stock and other options.
Two-Sided Transactions
Derivatives don’t eliminate risk, they simply transfer it.
Derivatives Applications and the Principles of Finance
Risk-Return Trade-Off
Another party must pensated to bear your risk.
Capital Market Efficiency
Use the financial markets’ consensus forecasts.
Comparative Advantage
If another party can bear a risk more cheaply, paying them to take the risk can add value and allow you to focus on your parative advantage.
Options
A call option gives the holder the right to buy one share of the underlying stock at a specified price within a stated time period.
A put option gives the holder the right to sell one share of the underlying stock at a specified price within a stated time period.
The fixed price is called the exercise or strike price.
Some Properties of Options
As stock price increases,
value of call option increases.
value of put option increases.
As exercise price increases,
value of call option decreases.
value of put option increases.
As the time to maturity increases,
value of call option increases.
value of put option increases.
Option Trading
Exchange-listed options
Chicago Board Options Exchange (CBOE)
American Stock Exchange
International Securities Exchange
Pacific Stock Exchange
Philadelphia St