BEC 2 | M7 - Financial Valuation Methods: Part 2

option
Click the card to flip 👆
1 / 29
Terms in this set (29)
option
contract that entitles the owner (holder) to buy (call option) or sell (put option) a stock or some other asset at a given price within a stated period of time
The 2 most common Option pricing models
Black-Scholes Model
Binomial Model (or Cox-Ross Rubenstein Model)
American style options can be exercised....
at any time prior to their expiration
European style options can be exercised....
only at the expiration or maturity date of the option
Accountants may use the Black-Scholes method in valuing stock when accounting for....
share based payments
Inputs into the Black-Scholes Model
Current price of the underlying stock
Option exercise price
Risk free interest rate
Current time until expiration
Measure of risk
Assumptions underlying the Black-Scholes Model
Stock prices behave randomly
Risk-free rate and volatility of the stock prices are constant over the options life
No taxes or transaction costs
Stock pays no dividends,
Options are European style
Limitations of the Black-Scholes Model
Due to the assumptions, results may differ from real prices
assumes instant, costless trading (unrealistic)
underestimates extreme price movements
no applicable to pricing American style options
The Binomial Model is also known as the...
Cox-Ross Rubinstein Model
The Binomial Model considers the underlying security ________________________________, as compared to the value ________________________ under the Black-Scholes Model
over a period of time, at a point in time
The Binomial model useful for valuing __________________ style options, while the Black-Scholes model is used for valuing _________________ style optionsamerican, europeanAssumptions of the Binomial ModelA perfectly efficient stock market The underlying security price will move up or down at certain points in time during the life of the optionThe results of applying the Binomial Model is a _________________________ showing the possible values of the options at different points in time or _________________tree diagram, nodesBenefits of the Binomial ModelCan be used for American style options Can be used for stocks that pay dividendsThe value of a bond is equal to.....the PV of its future cash flows (which consist of interest payments and the principal payment at maturity)Valuing Debt Instruments: Cash flows may be discounted using....a single interest rate, or multiple interest rates aligned with the degree of risk for each cash flowBonds paying a fixed coupon rate equal to the market rate for comparable bonds are issued at....par (face) valueIf a bond's coupon rate at issuance is less than the market rate, the bond is issued at....a discountIf a bonds coupon rate at issuance is more than the market rate, the bond is issued at,,,a premiumValuing Tangible Assets - MethodsCALM Cost Method Appraisal Method Liquidation Value Market Value MethodValuing Tangible Assets - Cost MethodThe value of the assets is based on the original cost paid to acquire the asset. Adjustments may be made for depreciation.Valuing Tangible Assets - Market Value MethodRequires similar assets be available in the marketplace to find comparable value. Two methods: 1) Replacement Cost - Cost to replaced valued asset 2) NRV - Sales price less selling costsValuing Tangible Assets - Appraisal MethodA professional appraiser determines the value of the assetValuing Tangible Assets - Liquidation ValueRepresents the amount that a company would get upon sale if the assets had to be sold today and assuming there is an active market for the assetValuing Intangible Assets - MethodsMIC Market Approach Income Approach Cost AppraochValuing Intangible Assets - Market ApproachRequires arm's length transactions in similar markets be used as reference for the asset to be valuedValuing Intangible Assets - Income ApproachFuture expected cash flows over the estimated useful life of the intangible asset are discounted to present value using discount rates reflecting the level of riskValuing Intangible Assets - Cost ApproachUse when there are no similar assets or transactions involving similar assets, and no reasonable estimates of future income Iterations of the approach include replacement cost and reproduction costWhen preparing accounting estimates, management must consider the following data and factors:Historical information Market information Expected usage Estimates from experts