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Derek Chau (13)
Chapter 23

Chapter 23 Notes

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Derek Chau

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Chapter 23 Options and Corporate Finance Basic Concepts Notes231 Optionsan option is a contact giving its owner the right to buy or sell an asset at a fixed price on or before a given datesome important definitions related to options are1Exercising the option The act of buying or selling the underlying asset via the option contract2Strike or exercise price The fixed price in the option contract at which the holder can buy or sell the underlying asset3Expiration date The maturity date of the option After this date the option is dead4American and European options An American option may be exercised at any time up to and including the expiration date A European option differs in that it can be exercised only on the expiration date232 Call Optionsthe most common type of option is called a call optiona call option gives the owner the right to buy an asset at a fixed price during a particular time periodthere is no restriction on the kind of asset but the most common options traded on exchanges are on stocks and bonds233 Put Optionsa put option can be viewed as the opposite of a call optionjust as a call gives the holder the right to buy the stock at a fixed price a put gives the holder the right to sell the stock for a fixed exercise price during the life of the option236 Combination of Optionsinvestor gets same payoff from 1 buying a put and buying underlying stock 2 buying a call and buying a zerocoupon bondif investors have the same payoffs from the two strategies the two strategies must have the same costthis leads to the result thatcost of first strategycost of second strategyprice of underlying stockprice of putprice of callpresent value of exercise pricethis relationship is known as putcall parity and is one of the most fundamental relationships concerning options238 An Option Pricing Formulathe value of a call option is a function of 5 variables1 the current price of the underlying asset which for stock options is the price of the shares of common stock 2 the exercise price 3 the time to the expiration date 4 the variance of
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