EGBJ
Topic Author
Posts: 475
Joined: Sun Jan 21, 2007 10:05 pm

What Exactly Is An "option"?

Tue Aug 07, 2007 5:58 am

Hi all,

Whilst I get the general idea of what an "option" is i've never understood the details...could someone please explain. Also, what is a "purchase right"...and while we're at it could someone also explain what exactly a "Memorandum of Understanding" and "Letter of Intent" is please.

I did a search...to no avail. If a thread already exists on these topics could somebody please direct me to it.

Thanks for any info,
Rich  Smile
 
phlstudent
Posts: 415
Joined: Tue May 23, 2006 12:59 pm

RE: What Exactly Is An "option"?

Tue Aug 07, 2007 6:12 am

There are some pretty decent descriptions of memorandum of understanding and letter of intent on wikipedia.

http://en.wikipedia.org/wiki/Memorandum_of_Understanding

http://en.wikipedia.org/wiki/Letter_of_intent
 
EGBJ
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Posts: 475
Joined: Sun Jan 21, 2007 10:05 pm

RE: What Exactly Is An "option"?

Tue Aug 07, 2007 6:26 am

So am I right in thinking an MoU is virtually the same as a LoI and that they are effectively agreements between two parties. How do they differ from a conventional contract? Wiki says they indicate "an intended common line of action, rather than a legal commitment"...what exactly does that mean?

Thanks again
Rich  Smile
 
srbmod
Posts: 15446
Joined: Tue Mar 20, 2001 1:32 pm

RE: What Exactly Is An "option"?

Tue Aug 07, 2007 6:28 am

An option is basically an agreement to purchase an a/c at a certain price if the airline (or leasing company) exercises any options. The price for the options is locked in. Say ABC Airways orders 25 a/c from a manufacturer at $50 million a piece. As part of the deal, they also agreed to 25 options, for which they would pay the previously agreed upon $50 million price. This can be beneficial for the airline (or leasing company) if the price for a brand new a/c goes up. Let's say that 2 years down the road, ABC Airways decides to exercise 15 of the 25 options. The manufacturer is now selling that a/c for $65 million each due to demand for the a/c. ABC Airways won't be spending $65 million for those 15 a/c; they'll be paying $50 million each.

From what I can gather "purchase right" is just another term for an option.
 
EGBJ
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Posts: 475
Joined: Sun Jan 21, 2007 10:05 pm

RE: What Exactly Is An "option"?

Tue Aug 07, 2007 6:38 am

Thanks Srbmod...that makes sense. A few more questions though. Do options expire?...if so when and also is there a limit to how many options a carrier can place at any one time. Furthermore...what advantage does the whole idea of options have to the manufacturer?

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moo
Posts: 4033
Joined: Sun May 13, 2007 2:27 am

RE: What Exactly Is An "option"?

Tue Aug 07, 2007 6:48 am

Options can also secure extra production slots on a manufacturing line, although this is not normal - essentially if a deal is good enough, the manufacturer could agree to guaranteed production slots on the line which allows for the carrier to 'buy now, pay later' in more ways that one (finance, purchase agreements with shareholders et al).

Quoting EGBJ (Reply 4):
Do options expire?...if so when and also is there a limit to how many options a carrier can place at any one time.

Options do expire, but 'when' depends on the negotiations between the carrier and the manufacturer, as well as how many.

Quoting EGBJ (Reply 4):
Furthermore...what advantage does the whole idea of options have to the manufacturer?

They have the potential of selling more during a period, and as that period expires they can approach option holding airlines and press them for a decision without any difficult negotiation.

Essentially an option is an 'almost sold' aircraft - all it takes is an option holder to say yes, no negotiation involved.

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