"More Firms Use Options to Gamble on Their Own Stock"
So reads the headline in
The Wall Street Journal's "Heard on the Street" column of Thursday, May 22, 1997.
Use this story to generate discussion when covering the "Options Supplement"
and/or the chapter on
Risk Management (Chapter 23 in the third edition of FCF) to highlight the growing
role of derivative instruments in corporate finance.
Historically, corporate
risk management covered the instruments, procedures and guidelines used in the
hedging against unexpected fluctuations in factor prices. But, according to this
article, ". . . in today's bull market, so many companies are betting on their own
stock, through options, that [corporate treasurers] now consider the practice prudent
financial management."
Several well-known firms, including Intel, Microsoft, and McDonald's are currently, or
have in the past, written puts or purchased calls on their own stock. Why is it done?
Certainly, it can be profitable, particularly in a market that seems able to rise
indefinitely.
More importantly, is this practice prudent? Ask students to consider the implications.
Have financial managers gone beyond hedging? Should they? What if
a firm were to buy puts and sell calls? How much disclosure
should investors
demand? And, as noted by Professor Clifford Smith in the article, might the firm's
option activities affect the timing of information disclosure?
All in all, the discussion possibilities extend beyond financial mechanics to issues of ethics,
prudence, and sound financial practice.
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