Real Options

Code:

2FI09

Acronym:

RO

Keywords
Classification	Keyword
OFICIAL	Management Studies

Instance: 2016/2017 - 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	51	Bologna Official Syllabus	1	-	4	28	108

Teaching language

English

Objectives

“For most investments, the usefulness of NPV rule is severely limited…, [modern finance] is now obliged to treat all major investment decisions as option pricing problems”

(Stephen A. Ross, MIT)

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 main aim is that students master the main valuation models of real options being able to apply them to real-world situations. 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. Aspects such as analytical skills and critical thinking will be essential throughout the course.

Working method

Presencial

Program

1. Real Options: Introduction & Motivation

1.1 Traditional methods for capital budgeting: the NPV; 
1.2 The shortcomings of the NPV rule;
1.3 The alternative to the NPV;
1.4 Real options: research areas and applications;
1.5 Are real options well established in practice?
1.6 The main types of real options.

2. Fundamental Concepts & Basic Models

2.1 Real options setting;
2.2 What managers do in practice;
2.3 The roles of uncertainty, irreversibility and flexibility;
2.4 The main inputs and value drivers;
2.5 Binomial lattice model;
2.6 The Black-Scholes model;
2.7 Margrabe model for exchange (real) options.

3. Advanced Real Options Models

3.1 The fundamental differential equation;
3.2 The value and the timing to invest;
3.3 The value and the timing to abandon;
3.4 Valuing sequential options (Enter and Exit);
3.5 Models with two stochastic variables (a brief note). 

4. Real Options Under Competition

4.1 Shared real options and the effects of competition; 
4.2 Hidden (exogenous) competition;
4.3 Real options and game theory;
4.4 Models for leader/follower investment decisions

5. Special Topics on Real Options

5.1 Investment Incentives;
5.2 Mergers & Acquisitions;
5.3 R&D and Patents;
5.4 Compensation Schemes and Agency Problems;
5.5 Entrepreneurial Financing

Mandatory literature

Dixit, Avinash and Robert Pindyck; Investment under Uncertainty, Princeton University Press, 1994
Trigeorgis, Lenos ; Real Options: Managerial Flexibility and Strategy in Resource Allocation, The MIT Press, Cambridge (MA), 1996

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

Designation	Weight (%)
Exame	50,00
Trabalho escrito	50,00
Total:	100,00

Calculation formula of final grade

Week-problems: 20% (2, 10% each); 3 students per group;

Group assignment: 30% (2 students); 3 students per group;

Final Exam: 50%