Behavioural Finance and Real Option Assignment Example | Topics and Well Written Essays - 3000 words

Behavioural Finance and Real Option - Assignment Example For instance, investing in a specific project, downsizing, and expansion or disposing of other projects. Others may include licensing, R&D and M&A. Real options differ from financial options in that financial options cover short maturities that usually expire in many months. On the other hand, real options contain longer maturity that expires in many years with some specific options having expiring dates that are not finite. The assets contained in financial options are the stock prices compared to business variables that are in real options. Such variables include market demand, cash flow and commodity prices. Hence, in the application of real options to analyze physical assets, there should be carefulness in choosing an underlying variable. The reason behind this is that volatility measures employed in the model relate to an underlying variable. In financial option, as a result of inside trade regulations, these holders’ option cannot influence stock price to their benefit. However, real options’ decisions increase the real options of the project value as there are strategic options that can be made by management . Real options have more value compared to financial options. Financial options for many years have been traded but real options just emerged recently more so in the market. The two options can be arrived at using same approaches inclusive of finite differences, differential equations, simulations and binomial lattices. The` reason is that binomial lattices can be easily explained and taken in by managers of a firm as the method is easily understood. Lastly, financial options base their facts on securities traded in markets and asset prices enabling them to be objective. At Real options, in contrast, are based on assets that are not traded in the market and seldom, there are proxies that are financially traded. Therefore, management assumptions are vital in  real options valuing and not important in financial option valuing. Given a specific project, the management is in a position to strategize which will help them in future.