The thesis examines options and risk management and the case of the biotechnology company Cephalon Inc. The company’s managers wanted to raise large amounts of capital to continue their business, through a risky financial derivatives transaction, the whose success depended on a decision by the FDA. They expected their drug Myotrophin to be approved, their share price to soar, making the purchase of call options on their own company’s shares a good strategy. The theory of options and cash flow hedging shows us the flaws in corporate managers’ decision making and offers us alternatives to financing choices. The strategy chosen has led the company to take on unnecessary risk for the sake of a more favourable accounting treatment, and thus to pay more than it should have. If a cheaper alternative had been chosen, the cash flow requirements for the Myotrophin rights purchase could have been met by issuing equity and using the company’s available funds, thereby reducing the risk significantly. The negative news from the FDA took executives by surprise as regulators did not approve the drug despite market expectations. This was a severe blow to the share price. The options therefore collapsed and company’s bet on their own drug proved to be very expensive compared to alternative sources of financing, which are described in detail in the seminar section of the thesis.
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