Valuation & Financial Analysis Flashcards

What does the term 'volatility' represent in the context of equity compensation valuation?

Answer: The annualized standard deviation of continuously compounded stock returns

Volatility in option valuation is the annualized standard deviation of the continuously compounded returns of the underlying stock.

When a company lacks sufficient trading history to calculate historical volatility, ASC 718 permits using:

Answer: A peer group's historical volatility or a blend of peer and own data

ASC 718 allows companies with limited history to use volatility of comparable peer companies or a blend of own and peer volatility.

A performance share unit (PSU) with a market condition (e.g., total shareholder return vs. peers) should be valued using:

Answer: Monte Carlo simulation

Market conditions must be incorporated into the grant-date fair value using a model such as Monte Carlo simulation that can model the probability distribution of outcomes.

Under ASC 718, once a grant-date fair value is determined for an award with a market condition, it is:

Answer: Fixed and not revised regardless of whether the market condition is achieved

For awards with market conditions, the grant-date fair value is set at grant and is not subsequently adjusted even if the condition is not met.

What is the primary reason companies use a lattice (binomial) model rather than Black-Scholes for certain stock option grants?

Answer: Lattice models can accommodate changing inputs over the option's life

Lattice models are flexible because they allow inputs such as volatility and interest rates to vary at different points in time across the option's contractual life.

Which of the following correctly describes the risk-free interest rate input in the Black-Scholes model for employee stock options?

Answer: The yield on U.S. Treasury securities with a maturity matching the expected term

The risk-free rate should correspond to U.S. Treasury securities (typically zero-coupon) with a term equal to the option's expected term.

A restricted stock unit (RSU) without dividend equivalent rights is granted when the stock price is $30 and pays no dividends. What is its grant-date fair value?

Answer: $30 minus present value of expected dividends

RSUs without dividend equivalent rights must be discounted for expected dividends because holders don't receive dividends during the vesting period; with no dividends, the fair value equals the stock price.