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Options Final 2010


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Introduction to Real Options

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Options Final 2010

  1. 1. Options<br />
  2. 2. Before we start…<br />3<br />Student Presentations<br />Summing up based on the live-tweets<br />7<br />Introduction<br />Introducing Real Options<br />11<br />Identify<br />Identifying options<br />28<br />Value<br />How to value Real Options<br />33<br />Manage<br />Strategy as a portfolio of real options<br />53<br />Summary<br />Summing real options up<br />60<br />The Exam<br />How to do great at the exam!<br />62<br />
  3. 3. Before We Start…<br />
  4. 4. .. I need three volunteers?<br />Before We Start…<br />
  5. 5. Tweet key learnings… <br />Before We Start…<br />MCF10<br />Control10<br />Password:<br />
  6. 6. Give a hand to thefellow students tweeting!<br />Before We Start…<br />
  7. 7. Student Presentations<br />
  8. 8. The assignment for every study group!<br />Every study-group should find 10 tweets that:<br />You find interesting / funny<br />That can serve as a either a summary of the lectures or that explores an important topic<br />Reflect on these tweets<br />As no one has uploaded a presentation we will turn this into a workshop – you have 20 minutes<br />Two groups will present<br />Student Presentations<br />
  9. 9. Student Presentations<br />Any volunteers?<br />
  10. 10. Student Presentations<br />If not then it will be….<br />
  11. 11. Introduction<br />
  12. 12. Introduction<br />An option is the right, but not the obligation, to buy (or sell) an asset for a predetermined price within a predeterminedperiod of time <br />Options arefinancial derivatives traded in financialmarkets<br />
  13. 13. Introduction<br />The value of an option depends on:<br /><ul><li> The time before exercising the option
  14. 14. The value of the underlying asset
  15. 15. The volatility of the asset
  16. 16. The strike price
  17. 17. The interest rate </li></li></ul><li>Definitions...<br />Introduction<br />
  18. 18. Life is Full of Options<br />
  19. 19. Real Options<br />Introduction<br />A Real Option is the right, but not the obligation, to invest in a business opportunity or chose a particular course of action for developing, growing or abandoning an opportunity.<br />
  20. 20. A Real Option in R&D<br />Introduction<br />In R&D, the (real) option is to develop a new technology or product, the investment is the project and the (underlying) asset is the future cash flows from product sales.<br />Real options are not traded in a market.<br />
  21. 21. Real Option and management flexibility<br />Introduction<br />watch & wait<br />abandon<br />engage & learn<br />abandon<br />staged development<br />commit & commercialize<br />abandon<br />invest & proceed<br />scale up/down<br />abandon<br />
  22. 22. Staging option and phase development<br />Introduction<br />earned value?proceed?<br />earned value?proceed?<br />product launch<br />abandon<br />abandon<br />initial investment<br />additional investment<br />final investment<br />
  23. 23. Introduction<br />Strategy is a sequence of options<br />So identify the options<br />
  24. 24. Flexibility can be truly valuable<br />
  25. 25. Driving without have a complete map<br />For most companies strategy is like driving without a complete map. Strategy schools talk about planned vs. emergent strategy<br />Introduction<br />Planning<br />Driving<br />Time<br />Having an incomplete map<br />Adapt to signs, road and<br />situation<br />Therefore it is important to identify and value your options and allow for management flexibility as new information arises<br />
  26. 26. What are the alternatives to Real Options?<br />Bets – Guessing<br />Net Present Value – several problems<br />Decision Tree – disregards risk of underlying assets<br />Introduction<br />
  27. 27. Problems of traditional NPV<br /><ul><li>It assumes that not investing results in flat line business performance
  28. 28. It does not account for management flexibility – meaning that decisions can be deferred
  29. 29. It does not account for potential growth options
  30. 30. It does not value value delay and uncertainty to the same sophistication</li></ul>Introduction<br />
  31. 31. Consider RO there is a high value of flexibility<br />Introduction<br />
  32. 32.
  33. 33. How to work with Real Options<br />Introduction<br />
  34. 34. Identify<br />
  35. 35. Identify options – look for the clues…<br />Identify<br />”Phases”, ”StrategicInvestment”, ”Milestones”, ”Alternatives”, ”Scenarios”, etc...<br />Examineprojectedcash flows: Identify the large investments – whichareoftendiscretionary – meaningtheyrequire a judgment and a decision.<br />
  36. 36. Two conditions must be present<br />Identify<br />
  37. 37. Identify the important options<br />Identify<br />What are the important things managers will learn over time<br />How will they use new information<br />Which decisions will change following new information<br />
  38. 38. 7S Framework – the different options<br />Identify<br />
  39. 39. Value<br />
  40. 40. Value<br />Flexibility has a value that should be accounted for in the valuation of a project<br />
  41. 41. An investment opportunity as a Call option<br />Value<br />
  42. 42. Value<br />
  43. 43. Value<br />When do NPV and Option Pricingdiverge?<br />WHEN THE INVESTMENT DECISIONS MAY BE DEFERRED<br />
  44. 44. Value<br />Conventional NPV misses the extravalueassociatedwithdeferralbecause it assumethat decisions can not be put off.<br />In contrast option pricingpresumes the ability to defer and quantify the value of deferral<br />
  45. 45. The two sources that drive value of deferral<br />Value<br />
  46. 46. Time Value of Money<br />Value<br />It is more attractive to investlaterthansooner..<br />..thus the firstsource of value is the time value of the moneyuntil the decision no longer canbedeferred<br />
  47. 47. Value of Volatility<br />Value<br />Uncertainty<br />The value of the underlying asset can go up ordown – wedon’tknow<br />
  48. 48. This relates to the metrics<br />Value<br />Value to Cost<br />NPVq<br />CummulativeVolatility<br />
  49. 49. The Value to Cost ratio<br />Value<br />Value to Cost<br />NPVq<br />NPVq is a modification of the traditional NPV turned into a ratio<br />
  50. 50. Value<br />
  51. 51.
  52. 52. Cumulative volatility<br />Value<br />CumulativeVolatility<br />Variance of returns per unit of time multiplied with the number of periods - which expresses cumulative variance. Cumulative Volatility is the square root of the cumulative variance<br />
  53. 53. Risk and Variance<br />Value<br />High Variance = High Risk<br />Low Variance = Low Risk<br />
  54. 54. Uncertainty and volatility is influenced by time<br />Value<br />Long time = Everything can happen<br />Short time = Changes are predictable<br />
  55. 55. Option Value<br />Value<br />
  56. 56. Value<br />
  57. 57. Appendix – A service from me<br />Value<br />
  58. 58. Potentially use a calculator<br />Value<br />
  59. 59. Manage<br />
  60. 60. Strategy as a Portfolio of Real Options<br />
  61. 61. The Tomato Garden – Defined by Two Option ValueMetrics..<br />Manage<br />
  62. 62. Low volatility<br />Manage<br />Volatility is very low, meaning uncertainty has been resolved or the time has run out<br />
  63. 63. Project that are in the money<br />Manage<br />Projects are ”in the money” =<br />NPV > 0<br />Reasonable predictions?<br />
  64. 64. Out of the money – but promising value-to-cost<br />Manage<br />Out of the Money, but pomising value to cost<br />Reseanoble Predictions<br />
  65. 65. The impact of time (holding everything else equal)<br />Manage<br />Interets that can be earned until investing decreases<br />Uncertainty <br />has<br />decreased<br />
  66. 66. Summary<br />
  67. 67. Summary<br />Summary<br />
  68. 68. The Exam<br />
  69. 69. The exam<br />No bullshitting – I’ve been there recently<br />Be pro-active – take initiative<br />Read the slides<br />Understand the key elements and connect the dots<br />Pre-<br />Prepare and make an effort<br />Then you will do great!!<br />The exam<br />