The Application Of Options In Financial Management

Option (OPTION), also known as option, is a contract, and its holder has the right to purchase or sell a specific subject matter at a certain price within a certain period of time (or at a specific date), but no obligation.

As a derivative financial commodity, the option came into being in the West in 70s. After the establishment of the Black Scholes option pricing model (0PM), it began to develop rapidly. Various kinds of financial derivatives emerged in an endless stream. 0PM also had more than 10 variants on the original basis to deal with different types of options trading and similar behaviors.

Options have rich connotation and increasingly complex trading skills. They are not only applied to financial engineering, but also used in investment, insurance, financial management and other fields, especially in financial management, and have been widely applied in financial management. They are as follows: 1. As a financial instrument, options have many notable characteristics as follows: first, the object of paction is a right, that is, the right to buy or sell a specific subject matter, but it does not bear the obligation to buy or sell. Second, this right has a strong timeliness, and the option will automatically fail if the expiration date is beyond the stipulated period. Third, the option has a small leverage effect. Up to now,

The rights and obligations of buyers and sellers of option contracts are asymmetric.

This shows that buyers have the right of performance without obligation and the asymmetry of risk and revenue.

For a buyer, he may make unlimited profits in the case of favorable price, and the biggest risk he takes is only the right to purchase the option, but the opposite to the seller.

This means that option investment can buy unlimited profit at the expense of limited royalty.

These characteristics make options very suitable to become effective means to avoid risks and increase returns.

Enterprises can invest idle funds in the options market, or invest in stocks and options at the same time. When they invest, they can predict risks (the maximum loss rights), but have the possibility of multiplying returns.

Once the market is bad, it can be reversed to compensate for the loss.

The effect is ideal than traditional trading tools.

This is also the main reason for the rapid development of option derivatives in the past twenty years.

In western countries, because of the burden of income tax and capital gains tax, some investors tend to hold options continuously until their short-term returns are converted into long-term capital gains, which can exempt from short-term income tax purposes.

Options are sometimes used for takeover strategies.

The purchase right of a Target Corp by a merger company.

When the amount of stock that has been purchased and the amount of stock that has been acquired has been reached, it must be declared to the securities and Exchange Commission.

This strategy reduces the takeover cost of merger companies.

These are examples of direct use of options as a means of financial management. In fact, any asset, no matter physical or intangible, can become the subject matter of an option. Even the option itself can become the subject matter, thus forming a compound option.

The continuous innovation of options enables pactions to be more flexible and more complete, and meet various risks and speculative needs of enterprises.

With the gradual standardization and maturity of China's financial market, we should also consider setting up an option trading market to give enterprises greater financial space.

Two, the application of option theory in pricing. Many securities issued by enterprises have obvious options characteristics, such as WARRANTS, RIGHTS and CONVERTIBLES.

They stipulate that the holder has the right (but no obligation) to buy or convert into the stock of the enterprise at the agreed price under certain conditions, which forms a right to buy and a timeliness.

When the share price rises, the more the holder will exercise the right to purchase, the more he will get the proceeds.

If they ignore the option characteristics, they will obviously underestimate the cost of these securities, overestimate the profits of the enterprises, distort the financial information of the enterprises, and are not conducive to financial decisions, so we must consider the option price contained in them.

For example, a convertible low coupon can be regarded as an option attached to a general bond.

As long as the annual standard deviation of stock return is obtained (not directly observed, it can be calculated according to historical data), it is possible to apply "Black - Scholes" OPM, which is very convenient to calculate the price of bond options, and the interest cost of bonds, which is the real financing cost of convertible bonds.

The above securities can be seen as a special case of stock options.

In fact, for indebted enterprises, equity and corporate bonds can also be seen as compound options.

Corporate bonds are issued by enterprises and represent the responsibility of enterprises. Shareholders are responsible for bonds.

If the interest is paid on a regular basis, the shareholder may perform the necessary repayment or breach of contract at the end of each period.

If they choose to pay, they will get a new option, otherwise the "option to pay" will be invalidated, and the loss will be the capital of their investment company.

In this way, a number of options with the option as the subject matter are formed.

Although these options are not clear enough, they provide an important in-depth understanding of the valuation process of the market.

In 1974, Robert and Morton published the article on the pricing of corporate debt, using OPM to solve the pricing problem of enterprises.

In 1977, he published an article on loan guarantee analysis, which helped to finance the successful implementation of large-scale projects.

We can see that options have wide application prospects in pricing. Any problem with "claim" or "option" can be considered in the framework of option theory.

Three, the option as an incentive means to solve the agency conflict. In the financial management, the agency conflict between shareholders and operators is always objective. Because of the inconsistent goal function of the two, there are many agency problems such as "moral hazard" and "adverse selection".

In principle, shareholders can supervise operators, but the cost of supervision is high and inefficient, and many behaviors are unobservable.

Therefore, "incentive" has become the main means to resolve agency conflicts, and EXERCUTIVE STOCK OPTION (ESO) is an effective incentive measure.

It gives managers the option to buy shares at a certain price in the future.

The incentive logic is to provide option incentives - managers work hard to maximize enterprise value and increase stock prices - managers exercise options to gain benefits.

On the contrary, the interests of managers are impaired.

This makes the personal income of managers become an increasing function of the company's long-term profits, making them think and act like owners, thus effectively reducing the agency cost and correcting the short-sighted behavior of managers.

According to statistics, 89% of 500 of the world's top companies have paid E5O compensation to their senior managers.

At the same time, the share of stock options in the total share capital of the company has increased year by year, only about 3% in 70s and 10% in 90s.

Equity income has become the main way of income collection for some operators, such as lNTER Andrew Grove, whose equity income was 94 million 590 thousand dollars in 1997, accounting for 96% of its total income.

China's Shanghai, Guangdong and other regions have begun to have pilot stocks.

At present, Wuhan state owned assets management company has become a hot topic of discussion for its wholly owned enterprises and holding enterprises.

Academia and business circles are very concerned about how to implement the ESO plan to establish China's long-term incentive mechanism, and to cultivate and cultivate entrepreneurs.

It can be seen that options play a unique role in resolving agency conflicts.

The biggest advantage is that the value of the company becomes an important variable in the income function of the manager, thus achieving the consistency of the interests of managers and shareholders.

At present, the stock market in China is still not standardized. Taking stock price as the subject matter of the futures stock is not scientific enough. The relevant provisions of the law also restrict the circulation of the stock market, and the operation environment of ESO needs to be improved.

To promote ESO, we must have corresponding laws and regulations to support it. Meanwhile, we should carefully study the performance evaluation index and design the ESO system suitable for China's listed companies.

There is no doubt that with the development of economy, the application of options in management will be deepened. Options and futures stocks will become increasingly familiar to the public.

Four, to assist long-term investment decisions, it is well known that the development of financial management has resulted in a relatively mature capital budgeting system.

The net present value method (NPV) and the internal rate of return (IRR) are commonly used methods for enterprises to make long-term investment decisions.

In particular, the net present value method is more in line with the hypothesis of maximizing the wealth of shareholders. In practice, it usually accepts (NPV>0) or refuses (NPVO) or investment now, otherwise it will not invest later.

However, many economists have pointed out that in most cases, investment can be delayed (such as new product investment), which is related to the nature of the project itself.

As long as an investment is postponed, in the face of external risks (such as market prices, interest rates, economic forms and other risks), enterprises should not be eager to give up, and may delay the current investment to gain more profits, depending on the development of the project.

In order to find more favorable investment opportunities, the right to postpone investment is an option.

Of course, obtaining this investment option must first invest in the necessary market position, human capital and technology, which can be regarded as the royalty of option.

At this time, investors only have rights and have no obligation to invest. When the market environment is favorable, he exercises his options. When the market is unfavorable, he can give up further investment, and the loss is only royalty.

For example, enterprises are faced with oil extraction projects (first to pay the right to exploit oil in 5 years, "from the perspective of net present value", and according to the predicted cash flow and discounting, the O of NPV should abandon the project.

However, we should analyze the framework of this option and regard it as the right to purchase the call option. The oil is equivalent to the basic assets. After paying the right to development, the company enjoys the right to exploit oil, but it has no obligation.

As long as the oil price exceeds the performing price and the cost of the option within the time limit for performance, the enterprise will be profitable to exploit, otherwise it will not develop the cost of development rights.

In this case, as long as the option price of the project is greater than the price of the development right, the project is acceptable.

The reason why this project is feasible is that it can provide investors with selectivity in the future investment, so the value of the investment project is the traditional NPV+ option value after the option.

This has corrected the net present value method.

The construction of many projects in the reality requires multiple investment to complete. Such investment decisions can be regarded as the choice of compound options. After each stage is completed, the enterprise has the option to complete the stage.

The investment decision is pformed into the most effective implementation of the option, and the whole stage of the project is combined to evaluate, making the decision more accurate.

The above analysis shows that the concept of options and its pricing methods have been widely applied in financial management.

Many problems become more understandable and precise after the introduction of option theory.

With the further innovation of options and the continuous development of financial theory, we may be able to solve more financial problems in the framework of options.