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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
       made
•      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
    bidder.
•   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
movie:
•      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
       produced.
•      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?
                      Assumptions



•    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
     sample)
•    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?
                          Calculations




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       C  SN d1   Ke  rT N d 2 

                            S 
                         ln  
                     d1     0.5 T
                             K
                                                        d 2  d1   T
                           T


• 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

                                                                  PV of
                                                PV of                        PV of expected     Change in
                                 PV of cash                     expected
            Studio/Movie Title                 negative                      cost at Maturity Expectations of
                                  inflows                      inflows at
                                                 cost                             (t=2)        Cash Inflows
                                                              Maturity (t=2)

years                                      1              0
MCA Universal
PARENTHOOD                         100.1         21.5             55.9            23.0            262%
BORN ON THE FOURTH OF JULY          74.5         19.4             41.6            20.8            169%
FIELD OF DREAMS                     59.1         17.2             33.0            18.4            114%
UNCLE BUCK                          60.0         16.1             33.5            17.3            117%
SEA OF LOVE                         53.5         26.9             29.9            28.8            93%
ALWAYS                              34.3         33.3             19.1            35.7            24%
K-9                                 37.8         12.9             21.1            13.8            37%
THE BURBS                           32.2         18.3             18.0            19.6            16%
THE DREAM TEAM                      28.4         16.1             15.8            17.3             3%
DO THE RIGHT THING                  30.0         7.5              16.7            8.0              8%
DAD                                 17.7         20.4              9.9            21.9            -36%
SHOCKER                             14.3          6.5              8.0             7.0            -48%
THE WIZARD                          12.7          8.6              7.1             9.2            -54%
RENEGADES                            6.9         12.9              3.9            13.8            -75%

DISORGANIZED CRIME                  7.8          11.8              4.4            12.6            -72%
CHEETAH                             9.2           7.5              5.1             8.0            -67%
Total                                   2740          1710
Average                                27.68         17.27            15.44              18.50            0.00
                                                                              Sigma                      150%
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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posted:4/10/2011
language:English
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