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Hedging - Advantages and Disadvantages of Aviation Fuel Hedging

   

Added on  2019-10-18

10 Pages2393 Words214 Views
HEDGING

HedgingTable of ContentsPart 1....................................................................................................................................................2Question 1.........................................................................................................................................2Question 2.........................................................................................................................................3Part 2....................................................................................................................................................4Introduction.....................................................................................................................................4Advantages.......................................................................................................................................4Disadvantages..................................................................................................................................6Conclusion........................................................................................................................................8References............................................................................................................................................91

HedgingPart 1Question 1The stock option should not be exercised because the current market price of £55 is less thanthe strike price of £65 i.e. a price which is paid to convert option into a stock. It will be morebeneficial to purchase stock at market price rather than exercise the option at strike price.The decision to exercise employee stock option depends upon the following determinants:Intrinsic Value: It is the difference between market price of the underlying stock of acompany and strike price of the option. If the intrinsic value is greater than zero, the optioncan be exercised by paying lower amount than the market rate. At any point of time, theintrinsic value shows the financial advantage available to the option holder if he chooses toexercise it immediately.Vesting Period: A vesting period is a time after which an employee can exercise his option.In our case, the vesting period is three years which means an option cannot be converted to astock before expiration of this period. The vesting period helps determine intrinsic value of astock after the time expires. The value thus obtained can be discounted back to the present toknow what would be the worth of an underlying stock if an option is vested. Longer vestingperiod means higher intrinsic value because a forecast for market price on a longer horizon ishigh.Time Value: There is a component of time value in the intrinsic value obtained of an option.The nominal value of a strike price is kept fixed though its real value may be different overtime. In our example, the strike price of £65 is applicable after three years till tenth year fromthe time when stock option is offered. However, if time value of money is considered,exercising option in 5th year at £65 will be less costly than doing it in 8th year at the same2

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