CEP Valuation & Financial Analysis 3

Question 1

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

Accepted Answer

The annualized standard deviation of continuously compounded stock returns

Answer

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

Question 2

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

Accepted Answer

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

Answer

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

Question 3

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

Accepted Answer

Monte Carlo simulation

Answer

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.

Question 4

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

Accepted Answer

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

Answer

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.

Question 5

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

Accepted Answer

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

Answer

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.

(CEP) Certified Equity Professional Practice Test

(CEP) Certified Equity Professional Practice Test

CEP Valuation & Financial Analysis 3