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Week 8 Tutorial Solutions

# Week 8 Tutorial Solutions - Solutions Tutorial Week 8...

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Solutions – Tutorial Week 8 Chapter 23 9. a. A five-year American call option on oil. The initial exercise price is C\$70 a barrel, but the exercise price rises by 5% 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%. 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%. 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 assets; that is, the developer can defer exercise and then

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Week 8 Tutorial Solutions - Solutions Tutorial Week 8...

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