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									      Financial Derivatives:
Arundel Partners: The Sequel Project

                                 Boris Agababov
                                 Ekaterina Kouznetsova
                                 Alexander Nagornov
                                 Alexander Parkhomenko
              Introduction of Arundel Sequel Project

Innovative idea: purchase sequel rights for films produced by
one or more major U.S. movie studios

•      Purchase sequel rights before the first films are even
•      Arundel does not make artistic judgments or select
       the rights for particular movies based on predictions
       for possible success
•      Advance cash payments for the rights at a pre- agreed
       price to help finance production of the initial film
      How does Arundel expect to benefit from the idea?

•   Arundel can exercise the right when the performance of
    the first film is known. Expect revenue: 70% of the
    original movie
•   If expected profitability is low or costs are too high to
    produce sequel Arundel can sell the right to the highest
•   The loss a no moviegoer sequel will be: “price they
    sold the right – price they paid for the right” :
    loss will be deductible from tax.
•   Arundel expects that gains from successful sequels will
    offset the losses
               When does Arundel buy the rights?

The sequel rights are purchased before production of first
•      Purchase sequel rights for entire production of studio
•      Unknown which movies are going to be produced at the
       moment Arundel purchases sequel rights.
•      Price and number of movies should be agreed before
       either parties know which films are going to be
•      Arundel don’t want to pay prices which reflects the
       opinion of the studio about the movie
•      Arundel pays the agreed price to an escrow account as
       soon the movie goes into production
       How much are the sequel rights worth in 1989?

•    We assume that the company buys sequel rights for the
     full sample portfolio (exhibit 6, a sample of 99 films)
•    The option is exercised when present value of cash
     inflows is higher than USD 27,7 mln (mean of the
•    If a sequel is produced, it is expected to generate 70%
of   the revenues of the original film.
•    The negative cost of a sequel is expected to be 120% of
     the negative cost of original film
•    Discount rate: 12% (Standard & Poor’s average for 1989)
           How much are the sequel rights worth in 1989?

Maximum price of the option should be such that Arundel generates 0 gain.
Estimated price of an option – maximum USD 3,6 mln
How much are the sequel rights worth in 1989?
           Sensitivity Analysis
                    Application of Black- Scholes Model

• Call price

• Parameters
    –   S = current value of underlying = expected Revenue of a Sequel discounted to t=0
    –   K = strike price = expected Cost of a Sequel (which has to be covered by revenue)
    –   T = time-to-maturity (in Periods)
    –    = standard deviation of S/S (S0 = avg, S1 = exp. revenue after first film)
    –   r = risk adjusted rate (here per Period)
    –   N(z) =cumulative standard normal probability density from - to z
Estimation of parameters for Black-Scholes
Estimation Results of Black-Scholes
                    Why Black-Scholes is not working?

•   Markets are efficient
•   Returns are normally distributed
Thank you for your attention!

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