Q&A with CMMB Securities

Q.The company I work for is planning to give some employees stock options. What do stock options do for me, and how do I take advantage of them?

Phillip,  Santa Rosa

A: Employee Stock Options Plans (ESOP) are given to employees of a company and they carry the right, but not the obligation, to buy a certain number of shares in the company at a predetermined price known as the exercise price. If the stock falls below the exercise price, the holder of the option loses nothing - he or she simply declines to exercise the option. The key point to note here is that the stock option gives to the employee only a right to buy the shares, not an obligation.

If, on the other hand, the stock rises above the exercise price, the option holder will make a profit equal to the spread between the market price and the exercise price. ESOPs are slightly different from regular options, in that they do not give the holder the right to sell shares in the company, referred to as put options.

Further, as a holder of Employee Stock Options, you must wait a specified period before you are allowed to exercise the option to buy shares in the company. The objective of ESOPs is to align the goals of the employee and management with that of the shareholders. The idea behind this is that a share in the company represents an ownership in that company and therefore employees would own that goal of maximizing the value of the company and by extension the share price.

Q.  Why does interest mean different things to different people?

Kamla, St. Joseph

A: Interest is the fee for the privilege of borrowing money. This fee represents the price a person pays for the ability to spend or consume in the present instead of having to wait for the future to do so. In other words, you pay for the opportunity to use money today that would otherwise take time to accumulate. On the other hand, if you were lending the money, you collect the fee (or interest) that compensates you for not being able to spend that money today. When interest rates change, everyone is affected - consumers, producers, government etc. If the rates increase, it will have an impact on the stock market performance since it will affect the future earnings of the firms.

Companies will find it more costly to borrow money for any new venture or even to improve existing business. The higher rates mean they will have to reward the lender with a higher rate of return. Consequently, the company’s stock price will begin to fall with the interest rate
increase. In fact investors and economists view higher interest rates as essential for contracting the economy.

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