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Quiz Notes FIN4424

by: Emily Michel

Quiz Notes FIN4424 FIN 4424

Emily Michel
GPA 3.7

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About this Document

Notes for upcoming Quiz, covers Derivatives
Problems in Financial Management
Dr. Don Autore
Class Notes
Derivatives, finance, options, Call, Put, Management, decision-making, incentive, stock, buy-back
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This 4 page Class Notes was uploaded by Emily Michel on Monday April 4, 2016. The Class Notes belongs to FIN 4424 at Florida State University taught by Dr. Don Autore in Spring 2016. Since its upload, it has received 29 views. For similar materials see Problems in Financial Management in Finance at Florida State University.


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Date Created: 04/04/16
FIN 4424 Notes 3/28/16-4/4/16 QUIZ NEXT MONDAY/WED. Case due week after. Final the week after that. Dividend announcement: shows not cash strapped, have disposable income. *When firms are going to increase dividends, means it is a pretty safe number because once they issue they will do everything possible to not cut dividends, if they do decrease their price plummets 1) 2/8-Declaration Date: announce and price typically moves up (signaling) 2) 2/19- With Dividend Date 3) 2/20- Ex-Dividend Date: must own stock before here to get dividend, value when paid will go down by $1, but value hasn’t decreased. 4) 2/22- Record Date: Must be on companies books as holder to receive (takes 3 days to get on books) 5) 3/18- Payment Date- date div. is paid What should the firms do? M&M irrelevance theory- investor can sell off own dividend, but doesn’t factor in signaling effect Clientele effect- cater to consumer base, so see if investors want/not want dividends -Counter: choose what you want to do and investors you want will come Derivatives: options, swaps, forwards and futures, not like in calculus **Options- a contract that gives the owner the right to buy/sell an asset (stock if stock option) at a fixed price on or before a given date. 1) right but not obligation to buy or sell is valuable, this is why options are not free. -They have a premium (or value/price) bc of this 2) Call= buy at fixed price 3) Put= sell at fixed price 4) Strike/Exercise=fixed price 5) At the given date it expires. Call Option; stock price(s)=$65; can enter into call option at x=$70. C=call option price=$3/share. *Can get expensive if you buy a lot… *Should you exercise this option right now? No, because you can buy them in the market at $65. -Now the price is at $71 and it is going to expire!, you should…? Take it & exercise it. You will still have a loss of -2 but that is better than -3 if you let it expire. *When should you buy? **Invented to prevent downside loss, because will only lose 3$ not the whole lot. 70 73 price 0 Call option-long term f p Short call *They are priced appropriately, there is no deal everyone wants…No free lunch * They are more expensive if expiration date is further out -right to buy at higher price, is less expensive because it is less likely to happen *when s=x=AT the money *when s>x in the $$ *when s<x out of the $$ -pay premium to have downside risk eliminated, gains are 1:1 Put Option: s=25; x=20; p=4 *when price starts to fall is when they become valuable. -Enron: price plummeted, put option would have been nice, if increase in put options there is speculation price will go down, can also be used as insurance *not unlimited gain, best thing would be price goes to nothing= *may already own shares, may not *If not, you can buy for 4 $, and then it goes to 0 and sell at $20 Short Put Long Put Shorting always has unlimited losses… Limited upside potential with long put With Options, would you prefer more volatility? Yes, because downside loss is limited. Volatility drives the price of the option. Ex: A & B: stock price and strike price same, same features, which one will be more costly for an option. The more volatile one! If not volatile it is not likely for the price to move, so not likely that will need to implement the option…therefore, its cheaper The seller of put options is betting that the price will not go down. When a company sells put options on its own stock, the price went up on avg. by 4% more than the average industry company. The selling of put options SIGNALS good news. Asymmetric info! Collect all premiums, and they all expire and are worthless. Question: WHO ARE BUYING THESE?? Answer: large institutional investors. They bought them to gain information in REAL time, buy the put options and then buy the stock! They know they are going to lose the investment in put options, have plenty of money to do this, and make a ton on it! These are private placement so no SEC approval. The company had insider info, trading on inside info is illegal so this is the way around it. Example: S=90 (stock price) *expires in 6 months C=10 (price for call option) X=90 (can enter into call here) Starts at $9000 A: $90 x 100 =$9000 (w/o option) B: $10 x 900 =$9000 (w/ option) Stock Prices: 20 85 90 95 100 200 A 2000 8500 9000 9500 10000 20000 B 0 0 0 4500 9000 99,000 Which strategy is riskier? B. How does the option reduce risk if this is the case?? The reason why the options are paying off more is because they took a position with 900 shares of the stock, v. 100 shares. Spent all the money on premiums, which is a lot riskier. Option C is a better comparison. C= $10 x 100 = $1000 and $8,000 in risk-free investment @ 2%= $8160 (from chart above..) C 8160 8160 8160 8660 9160 19160 **goes up proportionally with A **reduce risk when looking at SAME number of shares If drawing a payoff graph instead of profit, what would the graph look like? -Shift the graph upwards, so the line is the x-axis until makes ANY money, so the graph is not in the negative at all for long call option. Value Intrinsic= amt. in the money, 0 if not in the money Ex. Call Lower Bound- Max[S-x, 0] If s>x exercise; Upper Bound is if stock price is less than option price, might as well buy the stock (this is theoretical, doesn’t happen in reality)… Time Value= prob. Amt that could be in money V= Intrinsic+TV Determinants: Stock Price; Exercise Price (willing to pay more at 50 vs. 55); Time to Expiration(more time more value); Risk Free Rate (opportunity cost, increases as the risk free increases for call, put price decreases though because you do not have the cash) *Volatility: more volatile the more its worth, more chance it can move into the $$$ Executive Stock Options- How are they different?? –you don’t have to pay for them, they cant sell and there is no premium, only call options (if put options then the company would be giving incentive to drive price into the ground) **drives employees to get stock price up! EX: Stock at $200, Strike price (x)= $200, c= $20. For 10,000 shares. Stock price is now at 700! What is the payoff if exercised at this amount?? Costs -$2,000,000 ; sell the shares for $7,000,000 so the payoff is $5 Mil. $4.8 M is the profit; should you do the deal if you have 1 year left? Answer: You would not want to exercise the option because the payoff = s-x, =$500 M. Price could go up, sell option to other investment. V=Intrin. +TV would be your return. **American options are only options that can be exercised early.


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