DERIVATIVE MATH: NOT JUST A FINANCIAL TOOL
January 1 2004 by Chief Executive
Derivatives have become so much a part of the corporate financial and strategic toolkit that some companies use derivative math to crunch numbers for decisions that don’t even involve derivatives.
This so-called real-options analysis looks at staged investments in long-term projects-in areas ranging from pharmaceutical research to oil-field development-as if each cash commitment were an options purchase. Adherents say this provides a better picture of economic returns than traditional discounted cash-flow analysis.
“We don’t have a crystal ball. We need to think how the future may unravel and we need to understand the uncertainty we’re looking at,” says Alexander Van der Putte, senior strategy and portfolio advisor to the committee of managing directors at Royal Dutch/Shell. Within Shell, he says, there’s virtually a global network of people who are capable of analyzing a project in real-options terms.
-Gregory J. Millman