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Deriv Mkt & Fin Instit

by: Flavio Steuber

Deriv Mkt & Fin Instit FIN 462

Marketplace > University of Oregon > Finance > FIN 462 > Deriv Mkt Fin Instit
Flavio Steuber
GPA 3.66

J. Chalmers

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J. Chalmers
Class Notes
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This 3 page Class Notes was uploaded by Flavio Steuber on Tuesday September 8, 2015. The Class Notes belongs to FIN 462 at University of Oregon taught by J. Chalmers in Fall. Since its upload, it has received 72 views. For similar materials see /class/187163/fin-462-university-of-oregon in Finance at University of Oregon.


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Date Created: 09/08/15
To Prof Chalmers From Travis Ramme and Meghan Smith Date April 26 2007 Re Ms Chalmers Compensation Choices N E Ignoring taxation and other constraints Ms Jameson is better off taking the options The stock currently trading at 1875 and the exercise price is 35 This may seem drastically far away However 5 year TBill rates are currently at 602 Combined with a current stock volatility of approximately 42 this allows each option to be valued at approximately 493 At this amount Ms Jameson s options would be presently worth 14790 were she to sell them Where she to hold them instead Ms Jameson s potential upside is limitless Her possible gains would be equal to her number of options multiplied by the difference between the stock price and her exercise price of 35 assuming that the stock price is higher than 35 There is risk involved however If Ms Jameson decides to hold onto the options and not sell them it would be possible for her to earn nothing If the stocks price where to stay below 35 dollars Ms Jameson s options would be worth nothing Comparatively the 5000 cash bonus where it to be invested over the 5 years at the risk free rate of 602 would yield only 669744 If Ms Jameson was not allowed to sell her options before the allotted 5 years the choice to take the options would have much more inherent risk The current value of the options is derived from their market value This market value means nothing if Ms Jameson cannot sell the options If this where the case Ms Jameson s potential pro ts would be created solely by the Telstar stock rising to a price that was greater than 35 by the end of 5 years In fact to equal the 669744 value of the bonus she could have chosen instead the stock would have to reach a price of at least 3723 This value would allow the 3000 options to be exercised for a pro t of 669744 This however is ignoring the fact that Ms Jameson would have to pay taxes and transaction fees If Ms Jameson was not allowed to sell her options she should choose the 5000 up front bonus It represents a less risky asset Companies are often inclined to use stock options to compensate employees rather than exhausting cash ow It does not directly cost a company anything in terms of accounting costs There is however an implied economic cost equal to that of outside investors costs The cost of a stock option is more or less a perceived cost as the true value is not concrete and is virtually unknown at the time of issuance This is due to the length of the option and specified strike price 4 being of possible value at expiration date The current value of an option is dependent on the performance of the company and its stock price that is in the future Executive stock options help align an executive employee s monetary compensation with both individual performance and the overall performance of the firm In this sense an executive is encouraged to act in the best interests of the firm and to also to take some risks to grow the company in which they work for and thus increase the company s stock prices Stock options are an effective way to correlate performance and compensation but mainly only for employees that are in positions that can have an affect on the company s performance Employees in executive decisionmaking positions have the ability to impact the profitability and growth of the organization whereas administrative assistant positions would not be as likely to improve performance due to being compensated with stock options Companies could better individualize compensation packages for different positions Executive positions fit the stock options benefit plan while administrative assistants may prefer stock purchasing rights rather than options Other employees that fall somewhere in the middle would be better suited for a combination of monetary compensation stock options and stock in the firm In addition stock options with a lessened length of time to the expiration date may prove to drive optionholding employees to set shortterm achievable goals Employees would be given successive stock options to promote their care for the company without feeling as though they are being forced to stay with the organization This set up of granting stock options would also help to encourage performance of employees to lead to both the short and long term success of the firm If Ms Jameson decided that the option was a better deal but was concerned with being too committed and reliant on the fortunes of Telstar she could modify her compensation package to better suit her individual needs Ms Jameson would be taking considerable risk by keeping all of her bonus in Telstar for stock options with such a lengthy expiration date and also due to the historical data of Telstar showing that only stock prices reached 35 the exercise price only once Instead of holding on to all 3000 issued stock options Ms Jameson could keep a portion of the stock options and trade some in the market Keeping some Telstar stock options would help keep her tied to the company without making her feel that she is bound to the company for the next five years or that she is facing enormous risk of losing her bonus altogether By doing this Ms Jameson would provide herself with the opportunity to make investments outside of Telstar and thus better diversify her investments


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