Tuesday, October 16, 2012

Real options and Real life options

In finance, there is a concept of Real option valuation. It is a choice that a business may gain by undertaking certain endeavors. For example, by investing in a particular project, a company may have the real option of expanding, downsizing or abandoning other projects in the future.
The property of the real option is that they generally increase in value the more uncertain the values of the underlying variables. They generally increase in value the longer the time an option can be deferred.

Real life options are somewhat different. Real life options have many interdependent variables associated with it. And hence, unlike a real option, its value increases the more shorter the time duration of its expiry.
With a three/six month or 1 year real life option, it is very difficult to plan for medium term goals and perhaps even long term goals.

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