Deck 16: Real Options and Cross-Border Investment Strategy

Question 1

Exogenous uncertainty can create an incentive to speed up investment in order to gain more information about likely future prices and costs.

Answer 1

False

Question 2

The intrinsic value of an option is its present value assuming markets are informationally efficient.

Answer 2

False

Question 3

The time value of a real option reflects managerial flexibility.

Answer 3

True

Question 4

Option values increase with an increase in the volatility of the underlying asset, all else constant.

Question 5

Uncertainty is endogenous when the act of investing reveals information about price or cost.

Question 6

Real investment options gain value by avoiding bad times, whereas real abandonment options gain value by staying invested during good times.

Question 7

Option pricing methods suggest that imposing higher hurdle rates on immediate investment in uncertain environments is irrational.

Question 8

Option pricing methods suggest that managers immediately invest in real options with positive intrinsic values.

Question 9

The abandonment option is a form of put option.

Question 10

As the value of the underlying asset increases, the value of a call option increases.

Question 11

Uncertainty is exogenous when it is outside the firm's control.

Question 12

Firms should never invest in emerging markets if the expected net present value (when viewed as a "now or never" alternative) is negative.

Question 13

All else constant, exogenous uncertainty creates an incentive to postpone investment.

Question 14

Firms seldom remain in markets in which they are losing money.

Question 15

The time value of an option is its value as of a particular future date.

Question 16

Option pricing methods suggest that proper application of the NPV rule should consider when to invest and not just whether to invest.

Question 17

The decision to invest in a project today must be compared with the alternative of investing in the same or similar projects at some future date.

Question 18

An increase in uncertainty regarding the price at which a firm can sell the output from a foreign investment project leads to an increase in the value of the investment, all else constant.

Question 19

A part of the exercise price of the investment option is the foregone value from investing in a more attractive future project.

Question 20

Real options are options based on an underlying real (inflation-adjusted) price rather than on a nominal price.

Question 21

The value of the firm's growth options is reflected in the market value of equity.

Question 22

Call option values DECREASE with ______.

A) an increase in the underlying asset value
B) an increase in the volatility of the underlying asset value
C) an increase in the systematic risk (beta) of the asset underlying the option
D) More than one of the above
E) None of the above

Question 23

The value of growth options typically is included in the firm's reported financial statements.

Question 24

Multinational corporations usually make incremental investments into emerging markets because of the intrinsic value of these real investment options.

Question 25

Discounted cash flow and option pricing approaches to project valuation are incompatible; when one approach is used, the other should not be used.

Question 26

Endogenous uncertainty creates an incentive to speed up investment in order to gain additional information and resolve the uncertainty.

Question 27

Returns on options are approximately normally distributed.

Question 28

Option values are always more volatile than the asset values on which they are based.

Question 29

An option with more than one source of uncertainty is called a(n) _______ option.

A) amorphous
B) complex
C) compound
D) rainbow
E) switching

Question 30

Assets-in-place are those assets in which the firm has already invested.

Question 31

Managerial divergence from the NPV decision rule "accept all positive NPV projects" arises because ______.

A) managers' objectives can differ from those of shareholders
B) of the presence of real options
C) the NPV decision rule is not designed to maximize shareholder wealth
D) Three of the above
E) Two of the above

Question 32

The time value of an option to invest in a real asset reflects ______.

A) managerial flexibility in the timing of investment
B) the value of the asset as a "now or never" proposition
C) the value of the option to delay the project
D) Three of the above
E) Two of the above

Question 33

Firms continue to operate in unfavorable environments ______.

A) because the time value of the abandonment option is zero
B) to avoid the sunk costs of abandoning investment
C) when there is a chance that prospects will improve
D) Three of the above
E) Two of the above

Question 34

Call option values INCREASE with ______.

A) an increase in the exercise price
B) an increase in the volatility of the underlying asset value
C) an increase in the systematic risk (beta) of the asset underlying the option
D) More than one of the above
E) None of the above

Question 35

Which of the following statements applies to hysteresis?

A) Hysteresis occurs when there are both high entry and exit costs.
B) Hysteresis refers to the hysteria of a currency crisis
C) Hysteresis is a consequence of the intrinsic value of a "now or never" proposition.
D) Three of the above
E) Two of the above

Question 36

The value of an option to invest in a real asset reflects ______.

A) managerial flexibility in the timing of investment
B) the value of the asset as a "now or never" proposition
C) the value of the option to delay investment
D) Three of the above
E) Two of the above

Question 37

Managerial actions can appear to be inconsistent with the NPV rule because ______.

A) managers are irrational
B) markets are inefficient
C) options on real assets are difficult to value with NPV
D) Three of the above
E) Two of the above

Question 38

Real options include ______.

A) the expansion/contraction options
B) the investment/abandonment options
C) the suspension/reactivation options
D) Three of the above
E) Two of the above

Question 39

Hysteresis is the phenomenon in which firms fail to enter markets that appear attractive and, once invested, persist in operating at a loss.

Question 40

The intrinsic value of an option to invest in a real asset reflects ______.

A) managerial flexibility in the timing of investment
B) the value of the asset as a "now or never" proposition
C) the value of the option to delay investment
D) Three of the above
E) Two of the above

Question 41

Which of the following is FALSE?

A) Options are always more volatile than the assets on which they are based.
B) Returns on options are inherently non-normal.
C) Returns on options are asymmetric.
D) The volatility of an option changes with changes in the value of the underlying asset.
E) Option pricing methods discount option payoffs at a risk-adjusted discount rate.

Question 42

Uncertainty that is outside the firm's control is called _______ uncertainty.

A) amorphous
B) compound
C) endogenous
D) exogenous
E) foreign

Question 43

Financial options are easier to value than real options for each of the following reasons EXCEPT

A) Exercise prices on financial options are contractually written on a single financial price that is readily observable in the financial market.
B) Markets for real assets have fewer imperfections than financial markets.
C) Real asset markets typically are less competitive than financial markets.
D) Each of the above is a reason why financial options are easier to value.
E) None of the above is a reason why financial options are easier to value.