The Black And Scholes Model

Valuation is the estimation of an asset’s value, whether real or financial, based on variables perceived to be related to future investment returns, on comparison with similar assets, or, when relevant, on estimates of immediate liquidation proceeds (Pinto, Henry, Robinson, Stowe; 2010). Correct valuation of real assets can present challenges to financial analysts. Different models can be used to arrive at the closest estimate of value and yet certain issues will always arise. This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes Model for Real Options. Questions to be addressed in the study are:

It is believed that Efficient Market Theory is based upon some fallacies and it does not provide strong grounds of whatever that it proposes. More importantly the Efficient Market theory is perceived to be too subjective in its definition and details and because of this it is close to impossible to accommodate this theory into a meaningful and explicit financial model that can actually assist investors in making the investment decisions (Andresso-O’Callaghan, B., 2007).

Week 1 – Introduction – Financial Accounting (Review) Week 2 – Financial Markets and Net Present Value Week 3 – Present Value Concepts Week 4 – Bond Valuation and Term Structure Theory Week 5 – Valuation of Stocks Week 6 – Risk and Return – Problem Set #1 Due Week 7* – Midterm (Tuesday*) Week 8 - Portfolio Theory Week 9 – Capital Asset Pricing Model Week 10 – Arbitrage Pricing Theory Week 11 – Operation and Efficiency of Capital Markets Week 12 – Course Review – Problem Set #2 Due

The main reason why Laura Martin argues that real options is the correct method for valuing

The option contract can be a convenient solution for the buyer when the demand is difficult to predict due to market volatility. This type of contract helps the buyer to reduce the inventory risk and keep good relations with the suppliers, as they both agree to fix a price and adjust orders quantities after the demand have been determined, paying a reservation price that will be lost if the buyer decide not to exercise the option. For the supplier, sometimes can be beneficial, sometimes not, depending on the uncertainty in the demand and how much it cost for them to fulfill orders in shorter periods of time. However, as the buyer must pay a reservation price, the supplier will always be compensated by the additional revenue resultant from the option.

This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes

In accordance to this, MM provided assumptions to support their findings. These assumptions can be characterized by the existence of a perfect capital market where;

This document is authorized for use only by Yen Ting Chen in FInancial Markets and Institutions taught by Nawal Ahmed Boston University from September 2014 to December 2014.

The learning objectives for students in this course are: (l) improve your understanding of financial securities and markets, (2) develop the ability to analyze investment companies, common stocks, and bonds for investment decisions, (3) understand how options are

‘The Capital asset pricing model (CAPM) is a very useful model and it is used widely in the industry even though it is based on very strong assumptions. Discuss in the light of recent developments in the area.’

The success of the model is attributed to Yale’s ability to combine both quantitative analysis (mean-variance analysis) with market judgments to structure its portfolio. In addition, Yale also uses statistical analysis to actively test their models with factors affecting the market, therefore understanding the sensitivity of their portfolio in response to various market changes. Yale also follows and forecasts the cash flow of private equity and real assets in its portfolio to decide the need for hedging.

Outline the similarities and differences between the Single Index Model (SIM) and the Capital Asset Pricing Model (CAPM). Justify which of the two models makes a better assessment of return of a security (25 marks).

(5 points) In a world with no frictions (i.e., taxes, etc.), having debt is always better because it increases the value of the firm/projet.

Ever since Ross (1976) proposed the Arbitrage Pricing Theory (APT) as an alternative to the capital pricing model, many economists and investors have applied APT across different markets. Whereas the traditional capital pricing model explained asset returns with one beta, sensitivity to the market return, APT decomposes the return with a multiple number of factors. This idea became particularly popular for investors who aim to gain systematic risk other than market risk. However, the model specification aspect has been challenging to many practitioners as the theory does not require any specific sets of variables to be used (Azeez 2006).

Furthermore it is possible to buy and sell European option contracts, an option gave the holder the right to buy or sell the underlying futures contract at a predetermined price.