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Unformatted text preview: PROBLEM 11-1
Quantity Price (Year 0) P-high P-low Forward price Extraction costs 1000 $20 $25 $15 $20 $17 Solution L = Value given in problem = Formula/Calculation/An = Qualitative analysis or = Goal Seek or Solver ce = Crystal Ball Input = Crystal Ball Output Solution
Profit (sell today) Cert. Equiv (sell forward) $3,000 $3,000 Uncertain Profits $8,000 Extract oil only in this state of the world $(2,000) Do not extract oil in this state of the world 0.5 $4,000 You can lock into the forward r same spot rate. The payoffs u Selling today is better because Profit-high Profit-low Risk neutral probability Value of public land Equate forward price = expec neutral probabilities: 20 = 25 * p + 15 * (1 - p). a. It is better to wait because the option to wait is valuable (4000 vs. 3000). b. If the volatility in oil prices increases, the option value should increase. Conversely if volatility decreases, the option value decreases. Solution Legend
= Value given in problem = Formula/Calculation/Analysis required = Qualitative analysis or Short answer required = Goal Seek or Solver cell = Crystal Ball Input = Crystal Ball Output ou can lock into the forward rate or sell immediately at the me spot rate. The payoffs under either action is the same. elling today is better because of time value of money. Equate forward price = expected cash flows based on risk neutral probabilities: 20 = 25 * p + 15 * (1 - p). ...
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This note was uploaded on 07/24/2009 for the course FIN FIN taught by Professor Robbani during the Summer '09 term at University of Maryland Baltimore.
- Summer '09