Financial Derivatives:

Arundel Partners: The Sequel Project

Boris Agababov
Ekaterina Kouznetsova
Alexander Nagornov
Alexander Parkhomenko

Introduction of Arundel Sequel Project
Innovative idea: purchase sequel rights for films produced by
one or more major U.S. movie studios

Purchase sequel rights before the first films are even
made
Arundel does not make artistic judgments or select
the rights for particular movies based on predictions
for possible success
Advance cash payments for the rights at a pre- agreed
price to help finance production of the initial film

How does Arundel expect to benefit from the idea?

Arundel can exercise the right when the performance of
the first film is known. Expect revenue: 70% of the
original movie
If expected profitability is low or costs are too high to
produce sequel Arundel can sell the right to the highest
bidder.
The loss a no moviegoer sequel will be: price they
sold the right price they paid for the right :
loss will be deductible from tax.
Arundel expects that gains from successful sequels will
offset the losses

When does Arundel buy the rights?
The sequel rights are purchased before production of first
movie:
Purchase sequel rights for entire production of studio
Unknown which movies are going to be produced at the
moment Arundel purchases sequel rights.
Price and number of movies should be agreed before
either parties know which films are going to be
produced.
Arundel dont want to pay prices which reflects the
opinion of the studio about the movie
Arundel pays the agreed price to an escrow account as
soon the movie goes into production

How much are the sequel rights worth in 1989?
Assumptions

We assume that the company buys sequel rights for the
full sample portfolio (exhibit 6, a sample of 99 films)
The option is exercised when present value of cash
inflows is higher than USD 27,7 mln (mean of the
sample)
If a sequel is produced, it is expected to generate 70%
of the revenues of the original film.
The negative cost of a sequel is expected to be 120% of
the negative cost of original film
Discount rate: 12% (Standard & Poors average for 1989)

How much are the sequel rights worth in 1989?
Calculations
Maximum price of the option should be such that Arundel generates 0 gain.
Estimated price of an option maximum USD 3,6 mln
How much are the sequel rights worth in 1989?
Sensitivity Analysis
Application of Black- Scholes Model

Call price





Parameters
S = current value of underlying = expected Revenue of a Sequel discounted to t=0
K = strike price = expected Cost of a Sequel (which has to be covered by revenue)
T = time-to-maturity (in Periods)
o = standard deviation of AS/S (S0 = avg, S1 = exp. revenue after first film)
r = risk adjusted rate (here per Period)
N(z) =cumulative standard normal probability density from - to z
( ) ( )
2 1
d N Ke d SN C
rT
=
T
T
K
S
d o
o
5 . 0
ln
1
+
|
.
|

\
|
=
T d d o =
1 2
Estimation of parameters for Black-Scholes
Studio/Movie Title
PV of cash
inflows
PV of
negative
cost
PV of
expected
inflows at
Maturity (t=2)
PV of expected
cost at Maturity
(t=2)
Change in
Expectations of
Cash Inflows
years 1 0
MCA Universal
PARENTHOOD 100.1 21.5 55.9 23.0 262%
BORN ON THE FOURTH OF JULY 74.5 19.4 41.6 20.8 169%
FIELD OF DREAMS 59.1 17.2 33.0 18.4 114%
UNCLE BUCK 60.0 16.1 33.5 17.3 117%
SEA OF LOVE 53.5 26.9 29.9 28.8 93%
ALWAYS 34.3 33.3 19.1 35.7 24%
K-9 37.8 12.9 21.1 13.8 37%
THE BURBS 32.2 18.3 18.0 19.6 16%
THE DREAM TEAM 28.4 16.1 15.8 17.3 3%
DO THE RIGHT THING 30.0 7.5 16.7 8.0 8%
DAD 17.7 20.4 9.9 21.9 -36%
SHOCKER 14.3 6.5 8.0 7.0 -48%
THE WIZARD 12.7 8.6 7.1 9.2 -54%
RENEGADES 6.9 12.9 3.9 13.8 -75%
DISORGANIZED CRIME 7.8 11.8 4.4 12.6 -72%
CHEETAH 9.2 7.5 5.1 8.0 -67%
Total 2740 1710
Average 27.68 17.27 15.44 18.50 0.00
Sigma 150%
Estimation Results of Black-Scholes
Why Black-Scholes is not working?
Markets are efficient
Returns are normally distributed
Thank you for your attention!