If shareholders are more risk averse than managers are, it is a good idea to give...

If shareholders are more risk averse than managers are, it is a good idea to give managers call options with high strike prices? Discuss.

Expert Solution



Risk Averse
A risk averse investor avoids risks. S/he stays away from high-risk investments and prefers investments which provide a sure shot return.

Present problem

Manager are going to subscribe call option with high strike price which
indicates that company is expecting to have a huge increase in
it's market price of shares.

Illustration


Strike Price	Call Premium	Cash Market Price
95	20	110
100	15	110
130	10	110

SP>Mp
130>110	; investors are going to invest at high stike price with high expectations that price will increased beyond strike price.in these situation call premium is also get reduced.

Analysis

So buying call option by managers at high strike price will provide to the extent sureity to risk averse investors that
market price will increse in future at higher rate .

Hence ultimate gain would be higher as call premium at higher strike price is also low.

jeff jeffy answered 2 years ago

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