Applying options in real life Option pricing is applied across various functions in finance. Whereas speculators and option traders write and sell options in an option exchange, corporate finance also uses option pricing in such various areas as real options, risk management, capital structure decisions, and compensation plans.
Smoltz Motors has plants around the country that specialize in specific models of cars. Smoltz has determined that lower demand has led the firm's inventory of SUVs to be too high. Smoltz wants to stop production of its SUVs and focus on its sedans.
What kind of option does this example describe?
A. A real option to abandon
B. A real option to expand
Options are used in several capital structure decisions. TK Corp. decides to issue convertible bonds that will give investors the option to buy shares of the company at a certain price. You buy a convertible bond of TK Corp. at a coupon rate of 4.365% that matures in six years.
In which situation are you more likely to convert the bond or exercise the option?
A. When the issuer's stock price has decreased significantly
B. When the issuer's stock price has increased significantly