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L9 - Binomial OPM and Option to Delay

# L9 - Binomial OPM and Option to Delay - FINS3641 SAV Week...

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FINS3641 SAV Week 10: Binomial OPM and Valuation Implication of the Option to Delay 1 FINS3641 SECURITY ANALYSIS AND VALUATION PART 4 CONTINGENCY CLAIM VALUATION MODELS Week 10 Binomial Option Pricing Model Valuation Implication of the Option to Delay Topics: The binomial option pricing model explained Application of option pricing models to the valuation of patents and undeveloped reserves in natural resources Learning Outcomes: Learn how best to value patents and undeveloped reserves of natural resources Reading: Damodaran Chapters 5, 28

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FINS3641 SAV Week 10: Binomial OPM and Valuation Implication of the Option to Delay 2 The Binomial Option Pricing Model Step 1 : Set the number of evaluation periods between inception ( when the real option is 1 st available on the table ) and option maturity ( last chance to exercise the real option before it becomes obsolete ) If you increase the number of discrete periods, the paths taken by the underlying asset will become more continuous and contain less jumps Step 2 : Determine the “Value” of the underlying asset price paths: there are 2 periods and 6 nodes (A to F) in the following display t = 0 t = 1 t = 2 D S UU =100 B S U =70 A E S = 50 S UD =50 C S D =35 F S DD =25