HSBC 2004 Annual Report Download - page 340

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
338
number and weighted average exercise price of options is set out below.
Calculation of fair values
Fair values of share options/awards made in 2004, measured at the date of grant of the option/award, are
calculated using a binomial lattice methodology that is based on the underlying assumptions of the Black-
Scholes model. When modelling options/awards with vesting dependent on HSBC's Total Shareholder Return
over a period, these performance targets are incorporated into the model using Monte-Carlo simulation. The
expected life of options depends on the behaviour of option holders, which is incorporated into the option model
consistent with historic observable data. Prior to 2004, options were valued using a simpler methodology also
based on the Black-Scholes model.
The fair values calculated are inherently subjective and uncertain due to the assumptions made and the
limitations of the model used. The significant assumptions used to estimate the fair value of the options granted
in 2004 are as follows:
Group Share
Option Plan
3 year Savings-
Related Share
Option Schemes
5 year Savings-
Related Share
Option Schemes
Risk-free interest rate (%) ............................ 4.9 – 5.0 4.7 – 4.9 4.9 – 5.0
Expected life (years) 1 .................................. 6.9 3 5
Expected volatility (%) ................................ 25.0 25.0 25.0
1Expected life is not a single input parameter but a function of various behavioural assumptions.
The risk-free rate was determined from the UK gilts zero-coupon yield curve. Expected volatility is estimated by
considering both historic average share price volatility and implied volatility for traded options over HSBC
shares of similar maturity to those of the employee options. Expected dividend yield was based on historic levels
of dividend growth denominated in sterling.
Executive Share Option Scheme
The Executive Share Option Scheme is a long-term incentive scheme available to certain HSBC employees with
grants usually made each year. The aim of the plan is to align the interest of those employees assessed as higher
performing to the creation of shareholder value. This is achieved by setting certain Total Shareholder Return
targets which must normally be attained in order for the awards to vest. Options are granted at market value and
are normally exercisable between the third and tenth anniversaries of the date of grant, subject to vesting
conditions. No further grants will be made under the Scheme following the adoption of the Group Share Option
Plan in 2000.
2004 2003 2002
Number
Weighted
average
exercise
price Number
Weighted
average
exercise
price Number
Weighted
average
exercise
price
(000’s) £ (000’ s) £ (000’ s) £
Outstanding at 1 January ......................... 59,613 6.73 79,645 6.68 102,710 6.60
Exercised in the year ............................... (14,823) 6.62 (18,205) 6.50 (20,982) 6.26
Forfeited in the year ................................ (813) 6.90 (1,827) 7.07 (2,083) 6.91
Outstanding at 31 December ................... 43,977 6.76 59,613 6.73 79,645 6.68
The weighted average fair value of options as at the last date of grant during 2000 was US$5.26.
The number of options, weighted average exercise price and the weighted average remaining contractual life for
options outstanding at the balance sheet date, analysed by exercise price range, are as follows: