Essay on Arundel Case
1. Read and study “Introduction to Real Options”
2. Read and study CH 17 from McDonald: “Real Options”
3. Read and study CH33 from Hull: “Real Options”
4. Case: Arundel Partners: The Sequel Project
Answer the following questions:
a. What makes Arundel think it can make money by buying a package of sequel rights? Is the profit opportunity, if it exists, likely to be sustainable?
Arundel can make money selling the rights to a higher bid. Another option to make money is by producing the sequel exercising its rights but this will depend on if the net present value of the production movies is higher than the amount of buying the rights. If the future positive cashflows are undervalued Arundel can seek an arbitrage …show more content…
d. Explain how a sequel right can be viewed as a call option:
i. What is the underlying asset?
The sequel right will be the underlying asset and the cashflows are the assets, which depend on the underlying asset. It does not matter if the sequel have positive cashflows or not, the option will be the cashflows.
ii. What is the exercise price?
When you have a negative present value or cost of production will be the exercise price.
iii. What is the time to maturity?
iv. How might you estimate the volatility?
Calculating the standard deviation of the 1 year return. The standard deviation is 2.07.
v. Find a per sequel value by applying B-S. Assume rf = 0.06
e. Is Arundel likely to make more money by buying a package of sequel rights or sequel rights to specific individual films?
It will be better for Arundel to diversify the risk of the investment by buying the package of sequel rights because you can not know when the movie can go right or not. By buying this they are having a higher profit. Also, like the case said, it is important to know a price per film before the production start and before everyone know what movie will be produced.
f. Are the sequel rights that the studios are proposing to sell to Arundel something they receive for “free” as a result of producing the movie, or is there some explicit or implicit cost