2. Patriot Corp. compensates executives with 10-year European call options which

Question

2.     Patriot Corp. compensates executives with 10-year European call options which is granted at-the-money. If there is a signicant drop in the share price, the company’s board will reset the strike price of the options to equal the new share price. Then, the maturity of the repriced option will equal the remaining maturity of the original option. Suppose = 30%, r = 6%, = 0, and the original share price is $100. Calculate the following:

a. the value at grant of an option that will not be repriced

b. the value at grant of an option that is repriced when the share price reaches $60

c. the repricing trigger that maximizes the initial value of the option

Explanation / Answer

Answer: Number of Equity= 20

Maturity value of 10 years

Zero Coupon Bond= 200

Strike price of 8 warrants= 25

Price of the Warrant= 200 (25*8)

= 30%, r = 6%, = 0

Original Share Price= 100

a. Value at grant of an option that will not be repriced= (100-25)*8 = 600

b. the value at grant of an option that is repriced when the share price reaches $60 = (60-25)*8 =$280

c the repricing trigger that maximizes the initial value of the option

=100*1.06/1.3=81.5

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