10 Real Options - Real Options Valuation of real options in...

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FIN 819: Lecture 10 Real Options Valuation of real options in Corporate Finance
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FIN 819: Lecture 10 Today’s plan Review what we have learned in the last two lectures Real options Spot real options Value real options Use the Black-Scholes formula to value real options Use the risk-neutral probability to value real options Case discussion
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FIN 819: Lecture 10 What have we learned in the last lecture? In the last lecture, we have learned Use a binomial tree to value options What is the basic idea behind the approach? The risk-neutral valuation How to calculate u and d. The Black-Scholes formula There are five parameters
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FIN 819: Lecture 10 Revisit of Risk-neutral probability The price of call option is let p=(R f -d)/(u-d) < 1. Then - - + - - = - - + - - = + = d f u f f f u d d u C d u R u C d u d R R R d u dC uC d u C C B S C 1 ) ( [ ] d u f C p pC R C ) 1 ( 1 - + =
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Risk-neutral probability (continue) Now we can see that the value of the call option is just the expected cash flow discounted by the risk-free rate. For this reason, p is the risk-neutral probability for payoff Cu, and (1-p) is the risk-neutral probability for payoff Cd. In this way, we just directly calculate the risk- neutral probability and payoff in each state. Then using the risk-free rate as a discount rate
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This note was uploaded on 04/24/2010 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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10 Real Options - Real Options Valuation of real options in...

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