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Essay / Research Paper Abstract
This 4 page paper considers whether or not it may be viable to use option pricing theory, instead of traditional ratio analysis, as a way of assessing the risk associated with a firm. The paper considers the concept, looks at the Black-Scholes model and then assesses the suitability of the approach as a way of assessing risk. The bibliography cites 2 sources.
Page Count:
4 pages (~225 words per page)
File: TS14_TEoptratio.rtf
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Unformatted sample text from the term paper:
of traditional ratio analysis when seeking to assess the value of a firm and the risk it presents to a lender. It may be argued that the way options are
valued will indicate the way that the market believes that share price of a firm will move, which is deemed to be a reflection of the firms performance, as long
as there is a market for the options for that shares prices. If this is the case as well as being useful to investors they may be useful to lenders.
When lenders are assessing a firm, they are looking at the ability of the firm to repay and the potential of default. An inherent problem with the traditional approach
is the use of historical accounts, even management accounts are historical, and they may not be able to reflect the known information in the market about the market and the
firm. The use of option pricing theory is therefore a forward looking approach, whereas the ratio analysis is historical and looks back,
but it may also be seen as indicating the way that the share may move if only as a result of market speculation, as such it is allowing for this
extra risk. Where lenders seek to gain security of loans in the form of shares this may also be an assessment of that security. To assess if this is a
viable approach the models of option pricing theory can be considered. The Black-Scholes model is the dominant model optio pricing model, so
this is then model we will use. This model looks at the varying prices of financial instruments, specifically options and stock over time, recognising that they act in a volatile
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