Thomas Virolle

Pablo Méndez

Question 1

If we ignore tax considerations and assume that Sally Jameson is free to sell her options at any time after she joins Telstar she has several chooses. She can either choose to take the cash bonus, either take the options and sell it, or she can take the option and keep it until it is worth use.

Let’s compare the situations :

1- She takes the cash bonus and decide to invest it in a 5-year bond which rate is 6,02%. So at the end she will win 5310$ (=5000*1,0602).

2- She takes the options in order to sell it.

Let’s assume that it is easy to find someone who want to buy the option at the value of the call option.

Seeing the exhibit 3, the standard deviation of the Telstar common stock is 30%. S= 18,75

K= 35

r= 6,02%

t= 5

σ= 30%

So C= 2,9245

Assuming that she can easily and quickly find someone to buy her options, she can sell it at 3000*2,9245= 8773,5$

Then she could even invest these 8773,5$ in a 5years bond and win 8773,5*1,0602=9301,7$

3- She keeps the options until it is worth use it and sell her shares.

If she wants to earn more than she could have won by taking the cash bonus we have to find the value of the stock that would make her win more than 5301$

(X-35)*3000=5301 => X= 36,767

So when the value of the stocks is greater than 36,767, it will be worth using the option and sell the shares after. Sally Jameson will win more than 5301.

If she want to earn more than she could have won by selling the options, she will have to wait for the value of the stock to be :

(X-35)*3000=8773,5$ => X= 37,9245

If the value of the stock is greater than 37,9245 she will win more than if she sold the options.

Assumptions :

In 10years the Telstar Common Stock only reach 35$, so the chance the value of the stock goes up until 35$ is really low. And even more if we want to stock to be more than 36,767 for example.

(Bob Marks agree with that)

Conclusion :

The stock probably won’t go over 35$ so it is not worth keeping the option. And since taking the options, sell it and then invest it (making her win 9301,7$) is better than taking the cash bonus and invest it in a 5-year bond, the option package worth more.

Question 2

In this case, Sally Jameson can’t sell the options and has to pay taxes. So the selling option solution which was the better one in the first question is no longer available.

Now she has the choice between taking the cash bonus or using the options at the time of her fifth anniversary with the firm.

Let’s assume that Ordinary taxe rate is 28% and the capital gains taxe rate is 28%.

1- If she takes the cash bonus and she will get 5000*(1-0,28)=3600$. If she invests in a 5year bond she will get 3600+(3600*0,602*0,72)= 3756,04$

2- If she takes the options, and decide to use it and sell her shares :

She should wait the value of the stock to be higher than X if she wants to win more than with the cash bonus.

(X-35)*3000*0,72=3756,04 => X= 36,74$

Like in the first question, it is very unlikely that the value of the stock reach 36,74$ So this time, Sally should take the cash bonus.

Question 3

When a company gives stock option to its employees,it is the writer of the option and the employee is the holder of the option. So when the employee use the option, he pays the strike price to the company. Then the company wins cash and create new shares.

Given that the company sells to the owner of the option cheaper shares that the value of the underlying asset, we could say that the company loose money, or rather win less money (it could have won more money by selling the shares at the price market). In that way we could say that stock options have a cost. This cost wouldn’t be « paid » by the company but by the shareholders. Incentives :

* The holder of the stock option can avoid tax payments because tax on individual income is...