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