Financial Risk Manager Part 1
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A financial analyst, upon the directive of the CFO of a firm that does not issue dividends, needs to evaluate a proposal concerning the issuance of stock options to the company's employees. The firm currently has 60 million shares in circulation. The proposed plan involves issuing 3 million employee stock options, each of which allows the holder to buy one share of the company's stock at a strike price of SGD 70. These employee stock options will have a 4-year validity period. At present, a call option on the company's stock with a matching strike price and a four-year duration is valued at SGD 4.39, as calculated using the Black-Scholes-Merton model. What is the most precise estimate of the value of a single employee stock option, assuming the call option's pricing is correct?
A financial analyst, upon the directive of the CFO of a firm that does not issue dividends, needs to evaluate a proposal concerning the issuance of stock options to the company's employees. The firm currently has 60 million shares in circulation. The proposed plan involves issuing 3 million employee stock options, each of which allows the holder to buy one share of the company's stock at a strike price of SGD 70. These employee stock options will have a 4-year validity period. At present, a call option on the company's stock with a matching strike price and a four-year duration is valued at SGD 4.39, as calculated using the Black-Scholes-Merton model. What is the most precise estimate of the value of a single employee stock option, assuming the call option's pricing is correct?
Explanation:
The best estimate of the price of one employee stock option is SGD 4.18. This is calculated by taking the total number of shares outstanding (60 million) and multiplying it by the value of each call option (SGD 4.39). The resulting value per share is SGD 4.1809, which is rounded to SGD 4.18. This is the correct answer because it represents the value of the employee stock options based on the current market value of similar call options using the Black-Scholes-Merton model. The other options provided are incorrect for the following reasons:
- Option A (SGD 3.97) is the call option price minus the cost per share, which is not the correct method to determine the value of the employee stock options.
- Option C (SGD 4.39) is the value of each call option, not the employee stock option.
- Option D (SGD 4.45) incorrectly adds the call option price to the cost per share, which is not the correct approach for estimating the value of the employee stock options.