Question

What are the most common types of stock options available to the corporations? How those options are utilized? Is stock better than debt as a source of financing? Why or why not? Appraise your views.

Answer 1

The most common type of stock options available to corporations are;

1) Call options: This gives the right but not the obligation to buy the stock at a specific price in the future.

2) Put options: This gives the right but not the obligation to sell the stock at a specific price in the future.

These options are utilized by the companies to hedge against stock price fluctuations and to reduce volatility in their investment portfolio.

Pure equity may not be the best form of financing as debt allows firm the tax shield which can be used to augment firm value. Also using debt in the capital structure, the cost of capital decreases for the firm due to tax benefits. However too much debt might be bad for the firm as it increases the chance of bankruptcy and associated costs would be detrimental for the firm.