Real Options

Question 1

What is the Difference between Financial option and ROV?

Answer 1

ROV: Has the possibility, not the obligation, to abandon the business at any time, based on business deciscions & the underlying asset is not a stock.

Question 2

When we add another option, what happens to the value of the NPV and why is that?

Answer 2

The NPV will get a higher value and why this could be argued to be the case is because we have more options to make our project successful.

Question 3

In terms of Risky Debt, why is it called Risky?

Answer 3

Because there is a probable risk that the company won’t be able to pay back the money in the future.

Question 4

In terms of debt what are the three characteristics for a call?

Answer 4

○ Exercise price = The value of debt
○ Maturity = Maturity of debt
○ Underlying asset = Value of equity

Question 5

what is the risky debt decomposition?

Answer 5

Risky debt = Risk free debt - put

Where:
Risk-free debt = no bankruptcy in the future
Put = exercise if shareprice is lower than exercise price