Question

What options may be provided in financial securities?

i want long and professional answer please

Answer 1

Investors are constantly challenged with learning about and keeping current on a number of financial-related issues such as the volatile world of international investing, currency swings, creative accounting, bankruptcies, or the complex world of derivatives.

A financial option is a derivative instrument whose value depends on the volatility of the underlying financial securities from which it is derived. Financial options are a right, but not an obligation, to buy or sell an underlying financial asset at a fixed price over a specified time period.

Real options represent certain types of management decisions. The options models used to value real options are borrowed from financial options pricing models, but the underlying assumptions of these financial models do not strictly apply to real options. Real options are decision choices about real assets that a manager may exercise in the future. Many real options are contingent on more than one source of uncertainty and so should be classified as compound real options or options on an option. Real-life investment projects often include a collection of these compound real options whose values may interact.

An embedded option is a provision in a financial security (typically in bonds) that provides an issuer or holder of the security a certain right but not an obligation to perform some actions at some point in the future. The embedded options exist only as a component of financial security such as a bond or stock and cannot be separated from it. Although embedded options can be attached to any financial security, they are mostly included in bonds.

Options that provide rights to the issuers of a financial security contain the following provisions:

• Call provision: An issuer of a bond has the right to redeem a bond prior to the maturity date. The callable bonds generally have higher coupon rates to compensate the investors for the potential risk of the early repurchase of a bond.
• Capped floating rate provision: A bond with a capped floating rate provision specifies the maximum interest rate that an issuer will pay to the investors.

Options that deliver rights to the holders of a financial security come with the following provisions:

• Put provision: The holder of a bond has the right to demand early repayment of the bond’s principal amount. The embedded put option is exercisable on predetermined dates. Unlike callable bonds, puttable bonds carry lower coupon rates to compensate the bonds’ issuers.
• Convertible provision: The holder of a bond has the right to convert the bond into common shares at a predetermined rate at some point in the future. Additionally, a convertible provision is frequently attached to preferred shares.
• Exchangeable provision: The holder of a security (typically a bond or preferred stock) has the right to convert the security into the common shares of a company other than the issuer at a predetermined rate and at some point in the future.
• Extendable provision: The holder of a bond has the right to extend the maturity date of a bond. This type of embedded option is rarely used, and its primary application is taking advantage of long periods of declining interest rates.
• Floored floating rate provision: A bond with a floored floating rate provision specifies the minimum interest rate that the investors will receive from the issuer.