(a) Discuss how a decrease in the value of each of the determinants of the option price in the Black-Scholes option-pricing model for European options is likely to change the price of a call option.

(b) Weller Inc is considering the introduction of an executive share option scheme. The scheme would be offered to all middle managers of the company. It would replace the existing scheme of performance bonuses linked to the post-tax earnings per share of the company. Such bonuses in the last year averaged$1,500. If the option scheme is introduced, new options are expected to be offered to the managers each year. It is proposed for the first year that all middle managers are offered options to purchase 2,000 shares at a price of 200 cents per share, after the options have been held for one year. Assume that the tax authorities allow the exercise of such options after they have been held for one year. If the options are nonexercised at that time they will lapse. The company’s shares have a current market price of 280 cents. The shorter m risk-free interest rate is 4% annum, and the company’s share price has experienced a standard deviation of 25% during the last year.

Required: 

(i) Discuss the relative merits for the company of the existing bonus scheme and the proposed share option scheme.

(ii) Evaluate whether or not the proposed share option scheme is likely to be attractive to middle managers of Weller Inc.

(iii) When told of the scheme one manager stated that he would rather receive put options than call options, as they would be more valuable to him.

(1) Discuss whether or not Weller Inc should agree to offer him put options.

(2) Calculate whether or not he is correct in his statement that put options would be more valuable to him.

Answer rating: 100% (QA)

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