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Presentation on financial options, option valuation, and payout policy

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Presentation on financial options, option valuation, and payout policy

  1. 1. Financial Options Edoardo, Max, Tim 20/11/2017 Financial Markets EBC2006 Option Valuation Payout Policy
  2. 2. The Agenda p i c t u r e s presentation d i s c u s s i o n entertainment Data Case Chapter 17 Chapter 20 Chapter 21.1
  3. 3. Data Case Payout Policy Client: 1 million shares Bought at $13.98 on Feb 28, 2003 Dividend & Capital gain taks rate = 20% 4.95 Billion Shares Outstanding Share Price at Close Nov 15, 2017 = $34.11 Cash Jul 29, 2017 = $11,708,000,000
  4. 4. Data Case Payout Policy Half of Cash = $5,854,000,000 Share Repurchase Dividend Per Share =$5,854,000,000/$34.11 =171,621,225.45 =$5,854,000,000/4.95 Billion =$1.182626
  5. 5. Data Case Payout Policy Cash received from Dividend 1,000,000 Shares held 20% Dividend Tax dividend per share $1.182626 payout before taxes $1,182,626.00 taks payment $236,525.20 payout after taxes $946,100.80
  6. 6. Data Case Payout Policy shares held 1,000,000.00 shares repurchased 171,621,225.45 total shares outstanding 4,950,000,000.00 fraction owned by client 0.02% indirect repurchased 34,670.95 share price $34.11 payout before taxes $1,182,626.26
  7. 7. Data Case Payout Policy initial price $13.98 indirect repurchased 34,670.95 cost $484,699.95 payout before taxes $1,182,626.26 gain on sale $697,926.32 capital gain taks $139,585.26 payout after taxes $1,043,041.00
  8. 8. Data Case Payout Policy adjusted share price $32.93 shares held 1,000,000.00 cost $13,980,000.00 payout before taxes $32,927,374.00 gain on sale $18,947,374.00 capital gain taks $3,789,474.80 payout after taxes $29,137,899.20 dividend $946,100.80 total payout $30,084,000.00 Dividends
  9. 9. Data Case Payout Policy shares held 965,329.05 cost $13,495,300.05 payout before taxes $32,927,373.74 gain on sale $19,432,073.68 capital gain taks $3,886,414.74 payout after taxes $29,040,959.00 repurchase $1,043,041.00 total payout $30,084,000.00 Repurchase
  10. 10. adjusted share price $32.93 shares held 1,000,000.00 cost $13,980,000.00 payout before taxes $32,927,374.00 gain on sale $18,947,374.00 capital gain taks $3,789,474.80 payout after taxes $29,137,899.20 dividend $946,100.80 total payout $30,084,000.00 shares held 965,329.05 cost $13,495,300.05 payout before taxes $32,927,373.74 gain on sale $19,432,073.68 capital gain taks $3,886,414.74 payout after taxes $29,040,959.00 repurchase $1,043,041.00 total payout $30,084,000.00 RepurchaseDividends Q6: Under Which Program would you be better off before and after taxes?
  11. 11. Data Case Payout Policy Share Prices in 5 and 10 years Returns are 10% After dividend share price = $32.93 $32.93*1.10^5=$53.03 $32.93*1.10^10=$85.41 Repurchase share price = $34.11 $34.11*1.10^5=$54.93 $34.11*1.10^10=$88.47
  12. 12. Q7c: Calculate the total after taks cash flows at both points in time if the remaining shares are sold. 5 years 10 years adjusted share price $53.03 $85.41 shares held 1,000,000.00 1,000,000.00 cost $13,980,000.00 $13,980,000.00 payout before taxes $53,034,094.30 $85,411,939.21 gain on sale $39,054,094.30 $71,431,939.21 capital gain taks $7,810,818.86 $14,286,387.84 payout after taxes $45,223,275.44 $71,125,551.37 dividend $946,100.80 $946,100.80 total payout $46,169,376.24 $72,071,652.17 Dividends 5 years 10 years shares held 965,329.05 965,329.05 cost $13,495,300.05 $13,495,300.05 payout before taxes $53,029,864.68 $85,405,127.36 gain on sale $39,534,564.62 $71,909,827.31 capital gain taks $7,906,912.92 $14,381,965.46 payout after taxes $45,122,951.75 $71,023,161.90 repurchase $1,043,041.00 $1,043,041.00 total payout $46,165,992.75 $72,066,202.90 Repurchase
  13. 13. Data Case Payout Policy Share Prices in 5 and 10 years Returns are 20% After dividend share price = $32.93 $32.93*1.20^5=$81.94 $32.93*1.20^10=$203.89 Repurchase share price = $34.11 $34.11*1.20^5=$84.88 $34.11*1.20^10=$211.20
  14. 14. Q8: Calculate the total after taks cash flows at both points in time if the remaining shares are sold. 5 years 10 years adjusted share price $81.94 $203.89 shares held 1,000,000.00 1,000,000.00 cost $13,980,000.00 $13,980,000.00 payout before taxes $81,940,377.60 $203,893,880.39 gain on sale $67,960,377.60 $189,913,880.39 capital gain taks $13,592,075.52 $37,982,776.08 payout after taxes $68,348,302.08 $165,911,104.31 dividend $946,100.80 $946,100.80 total payout $69,294,402.88 $166,857,205.11 Dividends 5 years 10 years shares held 965,329.05 965,329.05 cost $13,495,300.05 $13,495,300.05 payout before taxes $81,933,842.62 $203,877,619.26 gain on sale $68,438,542.56 $190,382,319.21 capital gain taks $13,687,708.51 $38,076,463.84 payout after taxes $68,246,134.11 $165,801,155.42 repurchase $1,043,041.00 $1,043,041.00 total payout $69,289,175.10 $166,844,196.42 Repurchase
  15. 15. Q9: Calculate the NPV under both holding period assumptions. Dividend 5 years 10 years 10% $45,223,275.44 $71,125,551.37 20% $68,348,302.08 $165,911,104.31 NPV 10% 10% $28,080,096.02 $27,421,979.04 20% $42,438,918.16 $63,965,912.91 NPV 20% 10% $18,174,220.13 $11,487,173.63 20% $27,467,649.69 $26,795,569.61 dividend $946,100.80 $946,100.80 repurchase 5 years 10 years 10% $45,122,951.75 $71,023,161.90 20% $68,246,134.11 $165,801,155.42 NPV 10% 10% $28,017,802.90 $27,382,503.46 20% $42,375,479.88 $63,923,522.85 NPV 20% 10% $18,133,902.29 $11,470,637.16 20% $27,426,590.67 $26,777,812.25 repurchase $1,043,041.00 $1,043,041.00
  16. 16. Chapter 20 Financial Options
  17. 17. Basics A contract gives its owner the right to buy or sell an asset in the future at a fixed price. A gives the owner the right to buy the asset. A gives the owner the right to sell the asset. If the payoff from exercising an option immediately is positive the option is said to be If the payoff from exercising the option immediately is negative the option is said to be financial option call option put option in-the-money out-of-the-money
  18. 18. Concept Check 20.1 American option vs European Option Difference? Right to exercise American option on any date Does the holder of an option have to exercise it? No, he has a right but not an obligation
  19. 19. Option Payoffs at Expiration Call Value at expiration 𝐶 = max 𝑆 − 𝐾, 0 Put Value at expiration 𝑃 = max(𝐾 − 𝑆, 0) Long Position
  20. 20. Option Payoffs at Expiration Call Value at expiration 𝐶 = −max 𝑆 − 𝐾, 0 Put Value at expiration 𝑃 = −max(𝐾 − 𝑆, 0) Short Position
  21. 21. Net payoffs from Options Positive payoff only if: S > max(S-K, 0) + option premium x (1+i) t (call option) S > max(K-S, 0) + option premium x (1+i)t (put option)
  22. 22. Holding an Option to Expiration The more the options are out-of-the-money, the higher both risk and return Call option: positive beta and higher expected returns Put option: negative beta and lower expected returns Generally held to hedge risk in a portfolio
  23. 23. Combinations of Options 3 main investment strategies on options High volatility: 1)Straddle 2)Strangle
  24. 24. Combinations of Options 3 main investment strategies on options Low volatility: 3)Butterfly spread
  25. 25. Portfolio insurance Protective put (individual stock or portfolio level) 1)Stock + Put 2)Risk-free bond + Call
  26. 26. Put-Call Parity S + P = PV(K) + C 𝐶 = 𝑃 + 𝑆 − 𝑃𝑉 𝐾 − 𝑃𝑉(𝐷𝑖𝑣)
  27. 27. Factors affecting option prices A price of an option cannot be negative American option worth more than European counterpart Maximum payoffs: Put options: payoff=strike price Call options: payoff=stock price Extreme case: S=0
  28. 28. Factors affecting option prices Intrinsic value: value if the option expired immediately American option > Intrinsic value Time value: current option price – intrinsic value Maturity is relevant for American options Volatility, asymmetry in the option’s payoff
  29. 29. Exercising options early In which case? Non-dividend vs. dividend Non-dividend paying stocks: Call options Exercise option early is not optimal European option = American option
  30. 30. Exercising options early Non dividend-paying stocks Put options European option < American option
  31. 31. Exercising options early Dividend-paying stocks: Call options European option < American option
  32. 32. Exercising options early Dividend-paying stocks: Put options Opposite effect of the dividends
  33. 33. Exercising options early When to exercise the option early? 1)Non-dividend call  No 2)Non-dividend put  High strike price and deep in-the-money 3)Dividend call  Yes, if expected drop in stock’s price 4)Dividend  No
  34. 34. Options and corporate finance 3 ways to interpret the capital structure as options on the firms’ assets 1)Equity as a call option
  35. 35. Options and corporate finance 2)Debt as an option portfolio Risky debt = Risk-free debt – Put option on firm’s assets a)Assets – Equity Call option b)Risk-free bond – Put option (Short position)
  36. 36. Options and corporate finance 3)Credit Default Swap Risk-free debt = Risky debt + Put option on firm’s assets Insurance or speculation
  37. 37. Agency conflicts What is the agency conflict between equity and bond holders? The higher the risk: The better off will be the equity holders (call option) The worse off will be the bond holders (short position in a put option)
  38. 38. Chapter 21.1 The Binomial Option Pricing Model
  39. 39. A Two-State Single-Period Model ∆ = 0.5 B = -18.87 LOOP  option = replicating portfolio 50∆ + B = value portfolio Replicating Portfolio 60∆ + 1.06B = 10 40∆ + 1.06B = 0 50(0.5) – 18.87 = 6.13
  40. 40. The Binomial Pricing Formula
  41. 41. A Multiperiod Model Work Backwards from the last period to the first. S=50  C=6.13 S=30  C=0
  42. 42. The End
  43. 43. References • Corporate Finance 4th Edition, Pearson, DeMarzo & Berk

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