Real Options

Code:

2FI09

Acronym:

RO

Keywords
Classification	Keyword
OFICIAL	Management Studies

Instance: 2012/2013 - 2S

Active?	Yes
Responsible unit:	Management
Course/CS Responsible:	Master in Finance

Cycles of Study/Courses

Acronym	No. of Students	Study Plan	Curricular Years	Credits UCN	Credits ECTS	Contact hours	Total Time
MIF	23	Bologna Official Syllabus	1	-	4	28	108

Teaching language

English

Objectives

Real options is a major topic in corporate finance. It is intended that students develop the capacity to look at an investment project as an option or as a set of options, and not simply as a sequence of cash flows. This is a new and fundamental perspective to evaluate investment opportunities under uncertainty, irreversibility and flexibility. 

Learning outcomes and competences

The course will give special attention to the estimation of parameters, the choice and application of the models, the interpretation of results, and also to the adequate decision-making. The aim is also that students master the main valuation models of real options being able to apply them to real-world situations. Aspects such as analytical skills and critical thinking will be essential throughout the course.

Working method

Presencial

Program

1. The traditional capital budgeting: 1.1. Traditional methods for project valuation; 1.2. The shortcomings and limitations of the traditional rules.

2. Motivation for real options: 2.1. Options are everywhere; 2.2. Examples from real world; 2.3. Real options and flexibility: key aspects for strategic thinking; 2.4. Real options: research areas and applications.

3. The Real Options Theory in project valuation: 3.1. Introduction; 3.2. The importance of uncertainty, irreversibility and flexibility in the decision to invest; 3.3. The main types of real options; 3.4. The main "inputs" and "value drivers"; 3.5. Modeling real options.

4. Basic models for real options valuation: 4.1. Binomial lattice models; 4.2. Black-Scholes model for "vanilla" real options; 4.3. Margrabe model for exchange real options.

5. Advanced models for the firm’s decision: 5.1. The fundamental differential equation and the boundary conditions; 5.2. The value and the optimal timing to invest; 5.3. The value and the optimal timing to abandon; 5.4. Valuing sequential (or compound) options; 5.5. Models with two stochastic variables (a note).

6. Real options in a competitive environment: the option games: 6.1. The shared real options and the effects of competition; 6.2. The competitive impact coming from exogenous events; 6.3. Real options and game theory; 6.4. Models for leader/follower investment decisions.

7. Special topics on real options (research being carried out @ FEP)

Mandatory literature

Chevalier-Roignant, Benoît and Lenos Trigeorgis; Competitive Strategy: Options and Games, The MIT Press, 2011
Trigeorgis, Lenos ; Real Options: Managerial Flexibility and Strategy in Resource Allocation, The MIT Press, Cambridge (MA), 1996
Smit, Han and Lenos Trigeorgis; Strategic Investment: Real Options and Games, Smit, Han and Lenos Trigeorgis; Strategic Investment: Real Options and Games (2004), Princeton University Press, 2004
Dixit, Avinash and Robert Pindyck; Investment under Uncertainty, Princeton University Press, 1994

Teaching methods and learning activities

The teaching method includes moments where the main theoretical and conceptual aspects will be presented, and also moments where concepts and theories will be applied by solving real-world problems and case studies. In some of them, students will participate in the construction of models, from the assumptions to the final solution. Theory and practice will always be in line, in order to transmit the "intuition" about the models, as well as its usefulness and applicability. The aim is to give the students the ability to "see" an investment opportunity from the perspective of real options, identifying and applying the appropriate valuation technique, and also to decide in accordance with the results.

Evaluation Type

Distributed evaluation with final exam

Assessment Components

Description	Type	Time (hours)	Weight (%)	End date
Group assignment	Trabalho escrito		50,00
Final Exam	Exame		50,00
	Total:	-	100,00

Calculation formula of final grade

Group assigment: 40% (2 students);

Final Exam: 60%