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Assignment 5: SBC – Option-Pricing Models and Volatility

A. Option Pricing Models and Volatility Model

"Valuation techniques meeting SFAS 123(R)'s criteria are closed-form models, such as the Black-Scholes-Merton formula, and binomial models, such as the lattice model. The Black-Scholes-Merton formula is generally applied the same way to awards accounted for under SFAS 123 and prior pronouncements, except for the use of expected (as opposed to historical) volatility. Under SFAS 123(R), it must be adjusted to reflect certain characteristics of employee stock options that are not consistent with the model's assumptions, such as the ability to exercise the option prior to the end of its contractual term." [From Basic Principles in the New Accounting for Stock Options (The CPA Journal, September 2005)]

1. Black-Scholes Option Pricing Model

Prepare an EXCEL Spreadsheet Template of the Black-Scholes Option Pricing Model using the explanation contained in the following article:

No Longer an "Option" (The Journal of Accountancy, April 2005)
The EXCEL Template should have separate Input and Output Sections as illustrated in Exhibit 1: The formulas used for taking the Input Numbers and calculating the Output results should be hidden from view so that a user viewing your template will only see the input and output sections. Any numbers inserted in the Input section will automatically result in the output numbers being calculated.

Testing the Black-Scholes Model. Run the following sample data as a test of your model. Correct answers are indicated in RED. Please fill in the remaining blanks.
JofA Data Situation A Situation B Situation C
Current Stock Price (in dollars) $50.00 $105.65 $18.50 $62.50
Exercise Price (in dollars) $40.00 $105.65 $18.50 $62.50
Expected Life of Option (in years) 4 years 10 years 4 years 6 years
Risk Free Interest Rate 3.50% 3.25% 7.10% 6.40%
Volatility 35% 38% 13% 65%
Dividend Yield 1.50% .88% 0% .14%...