how to create barcode in vb.net 2010 FIVE Valuing Options in Software

Creation Data Matrix ECC200 in Software FIVE Valuing Options

CHAPTER FIVE Valuing Options
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Another consideration in granting options to individuals is the concept that risk is a highly personalized thing. Even among people with similar salary levels, what is an unbearable risk for one person may be tolerable for another due to a variety of factors, from age to marital status to temperament. Another factor that enters into the value is the amount of direct influence employees or executives have (or believe that they have) over the stock price. If someone s performance is deemed to have a direct impact on the stock price, then that person will tend to value options more highly. If someone s day-to-day responsibilities have no clear or direct impact on the stock price, the options will tend to mean less to them. Regardless of the circumstances, the fact remains that the very nature of options as high-risk derivatives tends to make them less valuable in the minds of people with undiversified portfolios. Thus a $10 option may cost the company $5 (reflecting the option expense), but it may only be worth $3 to the person who receives it. Multiplied by the millions of options granted, this $2 differential becomes significant. After all, the company is making a $5 investment in something worth only $3 to the recipient. Is the company going to get $5 worth of return out of this investment These factors must be taken into consideration as companies move ahead with their compensation policies and strategies. Luckily for companies the real-world experience of option grants can be factored into the formulas used to calculate the expense. For example the fact an executive cannot sell or trade the options received can be accounted for in the variables or boundary conditions used in option valuation models. In other words the unique characteristics of the executive option (long term, not tradable, vesting requirements, and likelihood of early exercise) must be included in the variables applied to Black-Scholes or any other valuation model. Let s say an executive receives options with a 10-year term. What typically happens is these options are exercised early, often after five to seven years. So this would shorten the term of the option from 10 years to five to seven years. Does that impede those options from being valued using Black-Scholes or any other model No. It simply means the shorter effective term of the option must be accounted for in the initial valuation calculation. It s like the old joke about computing: garbage in, garbage out. In order for executive
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options to be valued fairly and accurately, the assumptions or boundary conditions plugged into the formula must be fair and accurate. If not, then the fault does not lie with the formula but with the inputs (or the person entering the inputs) to the formula. Today there are numerous option valuation formulas, models, and methodologies. These include Black-Scholes and its variants, Binomial models, Trinomial models, Cox Ross, Gastineau, and so forth. Interestingly Najarian notes that when valuing traded options using these models, the calculations result in no more than a nickel difference in the valuations. There is even something known as the Coca-Cola method. The soft drink company, which grabbed the financial headlines in the summer of 2002 with its intention to expense options, came up with its own unique valuation method. Rejecting the option-pricing model approach, Coca-Cola said it would attempt to value its options by averaging solicited price quotes from two major investment banks. In other words the Coca-Cola method would seek input from the financial market to determine what the value of its options would be if these instruments could, indeed, be bought and sold. While this was an interesting idea, the investment banks ended up using option valuation models to determine their price quotes. The applicability and accuracy of Black-Scholes is evidenced in its wide usage. As Dr. Jeremy J. Siegel, professor of finance at the Wharton School of the University of Pennsylvania and author of Stocks for the Long Run (second edition, McGraw-Hill, 1998) noted, It [Black-Scholes] gave traders a benchmark for valuation where previously only intuition was used. The Black-Scholes formula was programmed on traders hand-held calculators and PCs around the
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FIGURE 5-1
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