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Analyzing article for Derivatives Risk and Management Class - Essay Example

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In everyday life, individuals always seem to be confronted with a lot of choices or options. Even choosing not to choose is still considered an option. In fact, as a person, what you have become today is merely a product of all decisions you have made from all the choices laid out to you in the past…
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Analyzing article for Derivatives Risk and Management Class
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Analyzing article for Derivatives Risk and Management Class

For mothers, they might have an option to be a plain housewife or to be a working mom. For working parents with meager income, they might have an option to start a new business and leave their jobs or to continue working for a company. All of these options seem to have a thing in common: uncertainty and the need of a decision. However, decisions are not made out of thin air; they have to be carefully woven and a well thought because any wrong move would affect the success of one’s own life. The question then is how to come up with a sound decision. In business sense, there are so-called financial options that give individuals the right, not an obligation to make a business decision---usually involving capital investments. Basically, there are two types of methods. One is the traditional method, commonly used is the net present value, which solely assess the financial value of the decision therefore ignoring any economic implications. The decision involved here will be very objective taking into account only the discount factors, cost of capital, etc. Using this method, if the computation produces a positive net present value, the investment must be pushed through. On the contrary, the second one, which is the real options method, is a modern approach to decision making. It takes into consideration the importance of a flexible management and a dynamic working atmosphere. Thus, clearly, it does not purely focus on the financial aspect of the decision but also on its economic value. Options start to surface as they pose new opportunities. Opportunities of growth are commonly the main reason why individuals are looking out on them rather than sticking to their present condition. However, the results of these opportunities may or may not materialize in the short-run, medium-term, or long run. There are a lot of factors to be considered before considering an option hence it may take some time to come up with a final decision. First is the irreversibility of the decision. Once a person is already at it, he/she cannot easily escape from the realms of his/her decision. Second, opportunity loss may be offset by waiting for the appropriate time to implement the action. In other words, an allowance for a delay in decision-making is provided in order to make more sound decisions. To meet these two requirements, there are these “real options” that are allows you to exercise what you want to accomplish in the future. To show a concrete example, consider a young man who recently graduated from a university with a bachelor’s degree in business administration. After finally getting out of the academe, he had in mind two options: to continue his studies in Law School or to work in the corporate world and earn money. In this case, whatever the decision is, a trade off will exist. Notice also that whatever decision he chooses, then it would be irreversible as it would mean a waste of time and money. If he goes to Law School, that means he has to forego the course that he has taken up for years and enter a new realm or school of thought. Therefore, there is an opportunity cost involved here. However, there is a need to do so in order to be flexible enough to face the world waiting for him outside the academe. Financially, it would not be favorable for him to take up law because he will just be spending another years in law school both with time and ... Read More
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