Question 1

If the project has an $80 annual cost requirement, what is the first year risk neutral expected cash flow?

Accepted Answer

A)  $93.99 
B)  $87.54 
C)  $13.99 
D)  $7.54 
A)  $93.99 
B)  $87.54 
C)  $13.99 
D)  $7.54 D

Question 2

What is the value of the project if the true probabilities are used and the appropriate one period risk adjusted discount rate is used (assume the $80 annual cost does not exist)?

Accepted Answer

A)  $169.65 
B)  $201.42 
C)  $233.73 
D)  $288.64 
A)  $169.65 
B)  $201.42 
C)  $233.73 
D)  $288.64 C

Question 3

The price of oil is $22 per barrel. The effective lease rate and risk free rate are 5.0% and 6.0%, respectively. The constant cost of extraction is $18 per barrel and the volatility of prices is 18.0%. What is the value of an option to defer extraction?

Accepted Answer

A)  $5.34 
B)  $6.34 
C)  $7.34 
D)  $8.34 
A)  $5.34 
B)  $6.34 
C)  $7.34 
D)  $8.34 B

Question 4

When answering the questions below, refer to the following table and related data.
Project Cash Flow Tree From a New Project
 $$\begin{array} { r r r } 
\text { Year 1 } & \text { Year 2 } & \text { Year 3 } \
120.52 & 155.67 & 222.64 \
65.24 & \mathbf { 8 4 . 2 7 } & 120.52 \
& 45.62 & \mathbf { 6 5 . 2 4 } \
& & 35.32
\end{array}$$ Effective annual risk free rate = 4.5% Expected market return = 10%
Cash flow beta = 1.4
The true probability of the high cash flow in a given period is 52.0%.
-What is the risk neutral probability of the first two years of the project cash flows moving down?

Accepted Answer

A)  40.3% 
B)  48.0% 
C)  52.0% 
D)  59.7% 
A)  40.3% 
B)  48.0% 
C)  52.0% 
D)  59.7%

Question 5

The current price of gold is $310.00 per ounce. The effective lease rate and risk free rate are 1.0% and 3.5%, respectively. If the cost to mine one ounce of gold is a constant $250, what is the value of an option to wait and mine the gold later?

Accepted Answer

A)  $135 
B)  $145 
C)  $155 
D)  $165 
A)  $135 
B)  $145 
C)  $155 
D)  $165

Question 6

Techie, Inc. may invest $5 million in a new Star Communicator project. Annual production costs and revenues are projected to be $2 million and $1.5 million, with each growing at 2.0% and 4.0%, respectively. At an interest rate of 5.5%, what is the approximate investment year that will maximize value? (Use static analysis.)

Accepted Answer

A)  Year 20 
B)  Year 15 
C)  Year 10 
D)  Year 5 
A)  Year 20 
B)  Year 15 
C)  Year 10 
D)  Year 5

Question 7

Why is the Black Scholes formula not viable when pricing a spread option for electricity?

Accepted Answer

An assumption of the Black Sch

Question 8

What is another term used to describe the forward price?

Accepted Answer

A)  Certainty equivalent 
B)  Elasticity 
C)  Risk neutral price 
D)  Value 
A)  Certainty equivalent 
B)  Elasticity 
C)  Risk neutral price 
D)  Value

Question 9

An existing well is operating and the price of oil is $45 per barrel. The effective lease rate and risk free rate are 3.0% and 4.0%, respectively. The constant cost of extraction is $25 per barrel and the volatility of prices is 15.0%. If it costs nothing to shut down the well, at what price would we close the well?

Accepted Answer

A)  $12 
B)  $25 
C)  $37 
D)  $49 
A)  $12 
B)  $25 
C)  $37 
D)  $49

Question 10

What is the main difference in pricing R & D options versus most other real options?

Accepted Answer

R & D options require continua

Question 11

Given the requirement of an $80 annual expenditure, what is the elasticity of the cash flows in period 1, with respect to the scenario in which no investment is required?

Accepted Answer

A)  1.40 
B)  7.08 
C)  9.68 
D)  11.62 
A)  1.40 
B)  7.08 
C)  9.68 
D)  11.62

Question 12

When answering the questions below, refer to the following table and related data.
Project Cash Flow Tree From a New Project
 $$\begin{array} { r r r } 
\text { Year 1 } & \text { Year 2 } & \text { Year 3 } \
120.52 & 155.67 & 222.64 \
65.24 & \mathbf { 8 4 . 2 7 } & 120.52 \
& 45.62 & \mathbf { 6 5 . 2 4 } \
& & 35.32
\end{array}$$ Effective annual risk free rate = 4.5% Expected market return = 10%
Cash flow beta = 1.4
The true probability of the high cash flow in a given period is 52.0%.
-What is the risk neutral probability of an upward movement in the project cash flows during the first year of operations?

Accepted Answer

A)  35.6% 
B)  40.3% 
C)  48.1% 
D)  59.7% 
A)  35.6% 
B)  40.3% 
C)  48.1% 
D)  59.7%

Question 13

The price of oil is $45 per barrel. The effective lease rate and risk free rate are 3.0% and 4.0%, respectively. The constant cost of extraction is $25 per barrel and the volatility of prices is 15.0%. If an untapped well costs $240 to open and can produce indefinitely, what is the value of the unopened well?

Accepted Answer

A)  $424 
B)  $554 
C)  $635 
D)  $785 
A)  $424 
B)  $554 
C)  $635 
D)  $785

Question 14

Given the requirement of an $80 annual cost, what is the value of the option to abandon the project in periods where the cash flows are negative?

Accepted Answer

A)  $10.86 
B)  $13.81 
C)  $33.52 
D)  $47.33 
A)  $10.86 
B)  $13.81 
C)  $33.52 
D)  $47.33

Question 15

What feature of the abandonment option makes the use binomial pricing more appealing than the Black Scholes pricing model?

Accepted Answer

Abandonment options allow inve

Question 16

Why is the perpetual call formula used to price commodity extraction options?

Accepted Answer

First, the option is a call si

Question 17

What is the value of the project assuming an $80 annual cost?

Accepted Answer

A)  $10.86 
B)  $13.81 
C)  $33.52 
D)  $47.33 
A)  $10.86 
B)  $13.81 
C)  $33.52 
D)  $47.33

Question 18

Mead, Inc. may invest $20 million in a new fiber optic project. Due to market conditions, annual production costs and revenues are forecasted at $10 million and $8 million, respectively, starting next year. Revenues are expected to grow at 4.0% and interest rates are 6.0%. What is the change in value if the project is commenced in 5 years instead of today? (Use static analysis.)

Accepted Answer

A)  $8.84 million 
B)  $10.84 million 
C)  $12.84 million 
D)  $14.84 million 
A)  $8.84 million 
B)  $10.84 million 
C)  $12.84 million 
D)  $14.84 million

Question 19

Use a binomial tree to value the following option. Assume rf = 0.04, rp =0.12, σ = 0.35, E(CF1) = $30, and cost = $300. What is the value of this project option?

Accepted Answer

A)  $40.74 
B)  $50.60 
C)  $55.32 
D)  $62.12 
A)  $40.74 
B)  $50.60 
C)  $55.32 
D)  $62.12

Question 20

In the context of peak-load energy generation and a European exchange option, what is the spark spread?

Accepted Answer

The difference betwe

If the project has an $80 annual cost requirement, what is the first year risk neutral expected cash flow?

What is the value of the project if the true probabilities are used and the appropriate one period risk adjusted discount rate is used (assume the $80 annual cost does not exist)?

The price of oil is $22 per barrel. The effective lease rate and risk free rate are 5.0% and 6.0%, respectively. The constant cost of extraction is $18 per barrel and the volatility of prices is 18.0%. What is the value of an option to defer extraction?

The current price of gold is $310.00 per ounce. The effective lease rate and risk free rate are 1.0% and 3.5%, respectively. If the cost to mine one ounce of gold is a constant $250, what is the value of an option to wait and mine the gold later?

Why is the Black Scholes formula not viable when pricing a spread option for electricity?

What is another term used to describe the forward price?

What is the main difference in pricing R & D options versus most other real options?

Given the requirement of an $80 annual expenditure, what is the elasticity of the cash flows in period 1, with respect to the scenario in which no investment is required?

Given the requirement of an $80 annual cost, what is the value of the option to abandon the project in periods where the cash flows are negative?

What feature of the abandonment option makes the use binomial pricing more appealing than the Black Scholes pricing model?

Why is the perpetual call formula used to price commodity extraction options?

What is the value of the project assuming an $80 annual cost?

Use a binomial tree to value the following option. Assume r_f= 0.04, r_p=0.12, σ = 0.35, E(CF₁) = $30, and cost = $300. What is the value of this project option?

In the context of peak-load energy generation and a European exchange option, what is the spark spread?

Introduction to Derivatives

An Introduction to Forwards and Options

Insurance, Collars, and Other Strategies

Introduction to Risk Management

Financial Forwards and Futures

The Wide World of Futures Contracts

Interest Rates Forwards and Futures

Swaps

Parity and Other Option Relationships

Binomial Option Pricing

The Black-Scholes Formula

Financial Engineering and Security Design

Corporate Applications

Filters

Exam 14: Real Options

If the project has an $80 annual cost requirement, what is the first year risk neutral expected cash flow?

What is the value of the project if the true probabilities are used and the appropriate one period risk adjusted discount rate is used (assume the $80 annual cost does not exist)?

The price of oil is $22 per barrel. The effective lease rate and risk free rate are 5.0% and 6.0%, respectively. The constant cost of extraction is $18 per barrel and the volatility of prices is 18.0%. What is the value of an option to defer extraction?

The current price of gold is $310.00 per ounce. The effective lease rate and risk free rate are 1.0% and 3.5%, respectively. If the cost to mine one ounce of gold is a constant $250, what is the value of an option to wait and mine the gold later?

Why is the Black Scholes formula not viable when pricing a spread option for electricity?

What is another term used to describe the forward price?

What is the main difference in pricing R & D options versus most other real options?

Given the requirement of an $80 annual expenditure, what is the elasticity of the cash flows in period 1, with respect to the scenario in which no investment is required?

Given the requirement of an $80 annual cost, what is the value of the option to abandon the project in periods where the cash flows are negative?

What feature of the abandonment option makes the use binomial pricing more appealing than the Black Scholes pricing model?

Why is the perpetual call formula used to price commodity extraction options?

What is the value of the project assuming an $80 annual cost?

Use a binomial tree to value the following option. Assume rf = 0.04, rp =0.12, σ = 0.35, E(CF1) = $30, and cost = $300. What is the value of this project option?

In the context of peak-load energy generation and a European exchange option, what is the spark spread?

Introduction to Derivatives

An Introduction to Forwards and Options

Insurance, Collars, and Other Strategies

Introduction to Risk Management

Financial Forwards and Futures

The Wide World of Futures Contracts

Interest Rates Forwards and Futures

Swaps

Parity and Other Option Relationships

Binomial Option Pricing

The Black-Scholes Formula

Financial Engineering and Security Design

Corporate Applications

Filters

Use a binomial tree to value the following option. Assume r_f= 0.04, r_p=0.12, σ = 0.35, E(CF₁) = $30, and cost = $300. What is the value of this project option?