Commenced in January 2007
Frequency: Monthly
Edition: International
Paper Count: 30308
A Zero-Cost Collar Option Applied to Materials Procurement Contracts to Reduce Price Fluctuation Risks in Construction

Authors: H. L. Yim, S. H. Lee, S. K. Yoo, J. J. Kim

Abstract:

This study proposes a materials procurement contracts model to which the zero-cost collar option is applied for heading price fluctuation risks in construction.The material contract model based on the collar option that consists of the call option striking zone of the construction company(the buyer) following the materials price increase andthe put option striking zone of the material vendor(the supplier) following a materials price decrease. This study first determined the call option strike price Xc of the construction company by a simple approach: it uses the predicted profit at the project starting point and then determines the strike price of put option Xp that has an identical option value, which completes the zero-cost material contract.The analysis results indicate that the cost saving of the construction company increased as Xc decreased. This was because the critical level of the steel materials price increasewas set at a low level. However, as Xc decreased, Xpof a put option that had an identical option value gradually increased. Cost saving increased as Xc decreased. However, as Xp gradually increased, the risk of loss from a construction company increased as the steel materials price decreased. Meanwhile, cost saving did not occur for the construction company, because of volatility. This result originated in the zero-cost features of the two-way contract of the collar option. In the case of the regular one-way option, the transaction cost had to be subtracted from the cost saving. The transaction cost originated from an option value that fluctuated with the volatility. That is, the cost saving of the one-way option was affected by the volatility. Meanwhile, even though the collar option with zero transaction cost cut the connection between volatility and cost saving, there was a risk of exercising the put option.

Keywords: Supply Chain Management, Construction Materials, Procurement, payment, Collar option

Digital Object Identifier (DOI): doi.org/10.5281/zenodo.1057309

Procedia APA BibTeX Chicago EndNote Harvard JSON MLA RIS XML ISO 690 PDF Downloads 1996

References:


[1] Akintoye, A, "Just-in-time application and implementation for building material management", Construction Management and Economics, vol. 13 no. 2,1995, pp. 105-113
[2] Barnes, S., Bassok, Y., and Anupindi, R, "Coordination and flexibility in supply contracts with options", Manufacturing and Service Operations Management, vol. 4 no. 3, 2002,pp. 171-207
[3] Barraza, G. A., Back, W. E., and Mata, F., "Probabilistic forecasting of project performance using stochastic S curves", Journal of Construction Engineering and Management, vol. 130 no. 1, 2004, pp. 25-32
[4] Bell, L. C., and Stukhart, G., "Attributes of materials management systems", Journal of Construction Engineering and Management, vol. 112 no. 1, 1986, pp. 14-21
[5] Bernold, L. E., and Treseler, J. F., "Vendor analysis for best buy in construction", Journal of Construction Engineering and Management, vol. 117 no. 4,1991, pp. 645-658
[6] Bettis, J. C., Bizjak, J. M., and Lemmon, M. L., "Managerial ownership, incentive contracting, and the use of zero-cost collars and equity swaps by corporate insiders", Journal of Financial and Quantitative Analysis, vol. 36 no. 3, 2001, pp. 345-370
[7] Boer, L. D., Labro, E., and Morlacchi, P., "A review of methods supporting supplier selection", European Journal of Purchasing & Supply Management, vol. 7 no. 2, 2001, pp. 75-89
[8] Boyle, P. P., and Turnbull S. M., "Pricing and hedging capped options", The journal of Futures Markets, vol. 9 no. 1,1989, pp. 41-54
[9] Briscoe, G., Dainty, A. R. J., and Millett, S., "Construction supply chain partnership: skills, knowledge and attitudinal requirements", European Journal of Purchasing & Supply Management, vol. 7no. 4,2001, pp. 243-255
[10] Carter, D. A., Rogers, D. A., and Simkins, B. J., "Hedging and value in the US airline industry", Bank of America Journal of Applied Corporate Finance, vol. 18no. 4,2006, pp. 21-33
[11] Cheng, F., Ettl, M., Lin, G. Y., Schwarz, M., and Yao, D. D., "Flexible supply contracts via options", Working paper, IBM T. J. Watson Research Center, Yorktown Height, NY, 2003
[12] Cox, J. C., Ross, S. A., and Rubinstein, M., "Option pricing: A simplified approach", Journal of Financial Economics, vol. 7no. 3, 1979, pp. 229-263
[13] Cui, Q., Bayraktar, M. E., Hastak, M., andMinkarah, I., "Use of warranties on highway projects: A real option perspective",Journal of Management in Engineering, 2004,vol. 20no. 3, pp. 118-125
[14] Dzeng, R. J., and Lin, Y. C., "Intelligent agents for supporting construction procurement negotiation", Expert Systems with Applications, vol. 27no. 1, 2004, pp. 107-119
[15] Eppen, G., and AnanthIyer., "Backup agreements in fashion buying-The value of upstream flexibility", Management Science, vol. 43no. 11, 1997, pp. 1469-1484
[16] Fuller, K. P., "Why some firms use collar offers in mergers", Financial Review, vol. 38 no. 1, 2003, pp. 127-150
[17] Halpin, D. W., "Construction Management", 3rd Ed., John Wiley & Sons, Inc. N.J, 2006
[18] Harper, D. G., and Bernold, L. E., "Success of supplier alliances for capital projects", Journal of Construction Engineering and Management, vol. 131 no. 9, 2005, pp. 979-985
[19] Lian, Z., and Deshmukh, A., "Analysis of supply contracts with quantity flexibility", European Journal of Operational Research, vol. 196 no. 2, 2009, pp. 526-533
[20] Linden, D. V., "Denomination of currency decisions and zero-cost options collars", Journal of Multinational Financial Management, vol. 15 no. 1, 2005, pp. 85-98
[21] Merrill, C., and Thorley, S., "Time diversification: Perspectives from option pricing theory", Financial Analysts Journal, vol. 52 no. 3, 1996, pp. 13-20
[22] Mun, J., "Real Options Analysis: Tools and Techniques for Valuing Strategic Investments and Decisions", John Wiley & Sons Inc, 2005
[23] Ng, F. P., Björnsson, H. C., and Chiu, S. S., "Valuing a price cap contract for material procurement as a real option", Construction Management and Economics, vol. 22 no. 2, 2004, pp. 141-150
[24] Officer, M. S., "Collars and renegotiation in mergers and acquisitions", The Journal of Finance, vol. 59 no. 6, 2004, pp. 2719-2743
[25] Officer, M. S., "The market pricing of implicit options in merger Collars", The Journal of Business, vol. 79 no. 1, 2006, pp. 115-136
[26] Polat, G., Arditi, D., and Mungen, U., "Simulation-based decision support system for economical supply chain management of rebar", Journal of Construction Engineering and Management, vol. 133no. 1, 2007, pp. 29-39
[27] Stukhart, G., "Construction Materials Management", Marcel Dekker Inc. New York, 1995
[28] Thomas, H. R., Riley, D. R., and Messner, J. I., "Fundamental principle of site material management", Journal of Construction Engineering and Management, vol. 131no. 7,2005, pp. 808-815
[29] Thomas, H. R., Sanvido, V. E., and Sanders, S. R., "Impact of material management on productivity-A case study", Journal of Construction Engineering and Management, vol. 115no. 3, 1989, pp. 370-384
[30] Tsay, A. A., and Lovejoy, W. S., "Quantity flexibility contracts and supply chain performance", Manufacturing & Service Operations Management, vol. 1no. 2, 1999, pp. 89-111
[31] Tsay, A. A., "The quantity flexibility contract and supplier-customer incentives", Management Science, vol. 45no. 10, 1999, pp. 1339-1358
[32] Wu, D. J., andKleindorfer P. R., "Competitive options, supply contracting, and electronic markets", Management Science, vol. 51no. 3, 2005, pp. 452-466