When Financial Derivatives can be Applied to the Real Economy – The Case of Exotic Options in Corporate Finance

Product complexity of financial derivatives makes them little accessible to most investors. To help investors better understand these instruments, it is important to show how these sophisticated products work in a “real economy” context by focusing on the economic rationale rather than on quantitative skills. Exotic options are tailor-made derivatives known for their flexibility and accuracy. The present article aims to illustrate how these complex products can be used in corporate finance. Our work may present a three-fold interest. First, it provides an overview on the most common applications of exotic options in corporate finance, more precisely in long-term investment decisions, long-term financing decisions, capital structure analysis, and executive incentive compensations. Second, by putting emphasis on the economic rationale, it seems to be relatively accessible for non-sophisticated investors. Finally, it shows corporate managers how to benefit from technical advances made in financial markets through the application of these techniques in corporate finance.