By T. Arnold
Aimed at practitioners with no earlier services within the subject, this book helps readers build simple genuine recommendations types to help in decision-making. Providing a pragmatic and informative procedure, the authors introduce uncomplicated chance theories, before placing those theories right into a real-world context.
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Extra info for A Pragmatic Guide to Real Options
These calculations are based on the underlying security return volatility and the risk-free rate (Cox, Ross, and Rubinstein, 1979). This will require a discussion of risk-neutral pricing in the next chapter. Further, only European style options have been priced with the binomial tree in this chapter. Real option analysis will require the pricing of American style options, which will be discussed in the next chapter. 05, and should always be more valuable. , the future stock price cannot go below zero).
This is what is meant by real option analysis being a means of recognizing hidden value in a project that is missed with an NPV analysis. The reality is that real options are created when an investment decision is made in a sequential fashion, which is often the case in reality, but possibly not always recognized. Value is not suddenly created by this sequencing because the nature or riskiness of the project does not change, but because the sequencing allows options to exist that make for better investment decisions.
Notice, an at-the-money call option and an at-the-money put option are not the same price. In fact, the at-the-money call option will always be worth more (see the next optional section). Although much has been accomplished with the binomial tree in this chapter, there are some issues that need to be resolved. How are U, D, P(U), and P(D) calculated within the binomial tree? These calculations are based on the underlying security return volatility and the risk-free rate (Cox, Ross, and Rubinstein, 1979).
A Pragmatic Guide to Real Options by T. Arnold