Real Options

Real options enable to solve corporate finance problems with customary financial options pricing models (Black& Scholes and Merton in continuous time, Cox-Ross-Rubinstein in discrete time). It also develops its own models as Dixit and Pindyck's for options with no expiration date in order to find the best timing invest.

Slides and the underlying Excel calculations are provided hereafter. They correspond to a slight extract of a more detailed Real Options course that has been taught for 7 years in the Master in International Finance of HEC Paris

• Equity valuation
• Growth option
• Value of a patent in the pharma industry
• Pricing of an oil concession
• Breakdown of the debt value taking LGD into account

Underlying Excel sheets corresponding to the abovementioned detailed content

Excel model

• Fischer Black and Myron Scholes explain in their seminal paper, published in 1973 by the Journal of Political Economy, that the shareholders have an option on their firm's assets. In other terms, the equity value is the call premium on the firm's assets, the strike price being the face value of debt ie the amount to be repaid: "The Pricing of Options and Corporate Liabilities": Paper
• Robert Merton proposes a formula to calculate the risk premium of a corporate debt in a paper published in 1973 by the Journal of Finance: "On the Pricing of Corporate Debt: the Risk Structure of Interest Rates": Paper