Real options Flashcards
(17 cards)
what are real assets
physical assets, factories, office buildings, everuthing basically
what is the call option in real options
The right to access a certain stream of potentially risky cash flows.
The future cash flows is the underlying asset.
what is an investment project?
The right to pay a certain investment amount to receive the present value of income streams
what is the connection between call options ans investment?
We can view any investment project as a call option.
what is static npv?
Performing NPV if we accept the project today
what is bad about static NPV?
it doesnt account for the option to wait.
in real options, what is the strike price?
The present value of all costs we will pay.
if we project entails taking on perpetual cost of say 0.9 usd, then the present value of this perptuity is our strike price.
this assumes, of course, that the stirke price doesnt change. For instance, if an investment require start-up costs at 10usd, and continuous cost of 0.9usd every year, if we are to consider this as the strike price, it must remain the same regardless of when we start the project.
elaborate on what happens in regards to the world of otpions when we have a project, and we choose to delay investment?
We give up revenue that we could have made.
This is analoguous to losing out on dividends.
what can we say abot the implicit put protection in a project that has certain cash flows?
there is no value for put protection because of no uncertainty.
why can we use options to value investments/projects?
Because valuation is a general term.
With stocks, we are valuying the current price based on uncertain future events.
with options, we are valuing the current price based on uncertain future events.
with projects, we are valuing the current price based on uncertain future events.
it is all the same.
is binomial model in real options based on no-arbitrage?
no, because we actually dont have the underlying to create replicating portfolio. it is therefore based on fair-price
what can we say about static nPV
lower bound
in simple terms, elaborate on the costs of a project in regards to the real option
Maybe wrong answre.
Initial costs are probably the premium. Initial costs is not the premium, it is what we compare against hte premium. The premium is the value we end up finding for the option.
Later costs is the strike price?
The case sort of becomes “is the initial cost worth it?”
with the real option, we can consider what the initial cost “should” be in order to provide a fair view. Then we can compare with the actual cost to determine whether to accept the project or not.
elaborate on using the binomial model to value investments
We start with the static NPV as the initial value. Then we use the regular cox-ross-rubinstein tree to build the project’s equivalent of the stock tree.
The stock tree’s final layer is then used in backward induction like always.
elaborate on the connection between lease rate and growth
no arbitrage implies that if you do not extract commodity, vs extract, the NPV must be teh same. Since you can get lease from extraction, leaving it in the ground must have an apprication as well.
what happens, generally speaking, if the cost of extraction, X, increase with time as well? For instance due to inflation
Accelerates the timing of the extraction
