Solutions_wk7 - Solutions Tutorial Week 8 Chapter 22 1 a A...

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Solutions – Tutorial Week 8 Chapter 22 1. a. A five-year American call option on oil. The initial exercise price is $50 a barrel, but the exercise price rises by 5 percent per year. b. An American put option to abandon the restaurant at an exercise price of $5 million. The restaurant’s current value is ($700,000/r). The annual standard deviation of the changes in the value of the restaurant as a going concern is 15 percent. c. A put option, as in (b), except that the exercise price should be interpreted as $5 million in real estate value plus the present value of the future fixed costs avoided by closing down the restaurant. Thus, the exercise price is: $5,000,000 + ($300,000/0.10) = $8,000,000. Note: The underlying asset is now PV(revenue – variable cost), with annual standard deviation of 10.5 percent. d. A complex option that allows the company to abandon temporarily (an American put) and (if the put is exercised) to subsequently restart (an American call). e. An in-the-money American option to choose between two
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