The valuation of options is a key part of the ACCA AFM syllabus and has been for a while. The valuation is carried out using the BSOP model. Nowadays, the ACCA AFM candidates have access to the new BSOP calculator, and the formula and related tables are to a large extent redundant.
Most of the questions test option pricing via real options. This is a naturally extension from investment appraisal and NPV/APV. Standard investment appraisal methods do not include the embedded options to delay, follow on or early exit from a project. The former two are valued as call options and the latter is a put option.
However, please note that option pricing and BSOP is not exclusive to real options under the current ACCA AFM syllabus. There are other aspects of option pricing that ACCA AFM students must be aware of, and these are explained below.
BSOP was originally designed to value share options, and this can certainly be tested by way of calculations in the exam, which I am led to believe it was in a recent unpublished question. Remember, not all ACCA AFM questions are published, just a sample. With this in mind, I have written a question and answer to allow students to see how to deal with share options in the exam.
Then, you have the ‘Greeks’. Not the people, the BSOP Greeks of delta, gamma, theta, rho and vega. Only the first three are examinable under the current ACCA AFM syllabus. Make sure you know what these are and pay particular attention to a delta hedge.
Finally, BSOP is also part of equity and debt valuation. All ACCA AFM students will know the variety of methods that can be used to value shares (Assets, P/E, FCFCo, FCFe, DVM and CIV). For bonds the main method is discounted future cash flows received by the bond holder.
In addition to those, a BSOP call option can be used to value shares and the put option to value bonds. However, this is discussion only in the syllabus.
Although real options is the main avenue taken by the ACCA AFM examining team, they do have other side streets they can enter.