Studying at York
Dynamic Capital Investment - MAT00124M
- Department: Mathematics
- Credit value: 20 credits
- Credit level: M
- Academic year of delivery: 2024-25
Module summary
In this module you will extend your toolkit with a theory and a spreadsheet-based implementation tool that help you to optimally value and time investment projects under uncertainty. A crucial aspect of most investment projects is that you can delay the investment. You don’t have to decide today. Maybe it is better to wait a few months, see how the business environment changes and then decide. As long as you haven’t made the decision to go ahead you still have the option to do so. This flexibility creates value for the decision maker. In this module you will learn a framework within which you can value this flexibility in an uncertain environment. Most of the problems we discuss in the module share features with commonly used financial instruments like European and American call and put options. However, where financial options are like prêt-à-porter fashion, real options are more like haute-couture in the sense that each problem needs to be thought about and understood on its own merits before a valuation model can be built.
Related modules
Some basic probability and statistics knowledge is required; basic knowledge of asset pricing is desirable but not required.
Module will run
| Occurrence | Teaching period |
|---|---|
| A | Semester 2 2024-25 |
Module aims
In this module you will extend your toolkit with a theory and a spreadsheet-based implementation tool that help you to optimally value and time investment projects under uncertainty. In previous modules you learned the basics of how to value a firm’s investment projects. Now, we will relax some of the assumptions we (implicitly) made:
- The project can be abandoned at will at no cost;
- The project can’t be postponed.
A crucial aspect of most investment projects is that you can delay the investment. You don’t have to decide today. Maybe it’s better to wait a few months, see how the business environment changes and decide then. As long as you haven’t made the decision to go ahead you still have the option to do so. This flexibility creates value for the firm. In this module you will learn a framework within which you can value this flexibility in an uncertain environment.
Module learning outcomes
After successfully completing the module you can:
- build a basic model for uncertainty evolving over time;
- formulate investment possibilities as option valuation problems;
- think like an investor to value several common types of options;
- implement these valuation models in Excel.
Module content
1. Introduction to market-based valuation of corporate projects
2. Thinking like an investor
2.1. Fundamental asset pricing equation
2.2 Expected returns and asset beta
2.3. Spanning assets and risk-adjusted rate of return
3. The binomial tree model for underlying (real) assets
3.1. The one-step tree
3.2. The multi-step tree
3.3 Pitfalls of using DCFs.
4. European-style real options
4.1. Growth options
4.2. Time-to-build options
5. American-style real options
5.1. Net convenience yield and early exercise
5.2. Options to defer
5.3. Options to abandon
5.4. Options to switch
Indicative assessment
| Task | % of module mark |
|---|---|
| Closed/in-person Exam (Centrally scheduled) | 80 |
| Groupwork | 20 |
Special assessment rules
None
Additional assessment information
Re-assessment for the group project will not be available. Instead, students will be assessed, during a closed-book exam, on similar skills (modeling and interpretation of outputs using spreadsheets).
Indicative reassessment
| Task | % of module mark |
|---|---|
| Closed/in-person Exam (Centrally scheduled) | 100 |
Module feedback
Formative feedback: weekly exercise sheets, discussed during practicals and seminars.
Summative feedback: comments on group work and closed-book exam.
Indicative reading
Textbook: - Thijssen, J.J.J. “Real Options”, lecture notes, available on Moodle.
Alternative: - Copeland, T. and V. Antikarov (2001), “Real Options – A practitioner’s guide”, Texere. [An applied text with the manager firmly in mind.]
- Dixit, A.K. And R.L. Pindyck (1994), “Investment under Uncertainty”, Princeton University Press. [THE classic for an academic audience.]
- Guthrie, G. (2009), “Real Options in Theory and Practice,” Oxford University Press. [Gives a nice mix between theory and practice.]
- Hull, J.C. (2018), “Options, Futures, and other Derivatives”, 9th edition, Pearson. [Industry standard for MSc finance courses; mainly covers financial derivatives.]
- Shockley, R.L. (2007), “An Applied Course in Real Options Valuation”, Cengage. [This title is unfortunately out-of-print, but if you can find a copy it is well-worth a read.]
- Trigeorgis, L. (1996), “Real Options: Managerial flexibility and strategy in resource allocation,” MIT Press. [An early classic at a level between, say, Guthrie and Dixit & Pindyck.]