1. Some refer to common stock in a company with debt outstanding as an option on a company's assets. Do you see any logic to this statement? What is the logic, if any?
2. The common shares of Fortune Brands, Inc. (FO), owner of many brands including Knob Creek bourbons, Wild Horse wines, Titleist golf products, and Swingline staplers, are trading today on the New York Stock Exchange for $54.04 a share. You have employee stock options to purchase 1,000 FO shares for $54 per share. The options mature in three years. The annualized volatility of FO stock according to the Chicago Board Option Exchange (CBOE, www.cboe.com/data/ historicalvolatility.aspx) in a recent month was 19.846 percent. The company's dividend yield is 1.41%, and the interest rate is 2.5 percent. (Assume the options are European options that may only be exercised at the maturity date.)
a. Is this option a call or a put?
b. Using Robert's Option Pricer at www.intrepid.com/robertl/ option-pricer1.html or any other calculator you prefer, estimate the value of your FO options.
c. What is the estimated value of the options if their maturity is five months instead of three years? Why does the value of the options decline as the maturity declines?
d. What is the estimated value of the options if their maturity is three years, but FO's volatility is 45 percent? Why does the value of the options increase as volatility increases?