Question 1

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

Accepted Answer

The difference between the price of electricity and the cost of generation.

Question 2

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 B

Question 3

The current price per ton of iron ore is $145.00.The effective lease rate is 3.0% and the risk free rate is 4.5%.The cost to mine one ton of iron ore is $110.00 and constant.What is the trigger price at which we will mine the iron ore?

Accepted Answer

A)  $163.80 
B)  $180.40 
C)  $210.50 
D)  $205.70 
A)  $163.80 
B)  $180.40 
C)  $210.50 
D)  $205.70 A

Question 4

The price of oil is $115 per barrel.The effective lease rate and risk free rate are 3.0% and 4.0%,respectively.The constant cost of extraction is $85 per barrel and the volatility of prices is 15.0%.If an untapped well costs $2,100 to open and can produce indefinitely,at what price per barrel should the well be opened?

Accepted Answer

A)  $349 
B)  $423 
C)  $454 
D)  $484 
A)  $349 
B)  $423 
C)  $454 
D)  $484

Question 5

The current price per cord of lumber is $26.00.The effective annual lease rate is 2.0% and the risk free rate is 4.0%.The cost to harvest one cord is $20.00 and constant.What is the trigger price at which we will harvest the lumber?

Accepted Answer

A)  $27.61 
B)  $31.61 
C)  $35.61 
D)  $39.61 
A)  $27.61 
B)  $31.61 
C)  $35.61 
D)  $39.61

Question 6

What is the relationship,in general,between volatility and trigger prices,assuming constant costs?

Accepted Answer

Higher volatility in

Question 7

The current price of silver is $32.00 per ounce.The effective lease rate and risk free rate are 3.0% and 4.0%,respectively.If the cost to mine one ounce of silver is a constant $25.00,what is the trigger price per ounce at which the silver will be mined?

Accepted Answer

A)  $33.17 
B)  $35.17 
C)  $37.17 
D)  $39.17 
A)  $33.17 
B)  $35.17 
C)  $37.17 
D)  $39.17

Question 8

Use Cox-Ross-Rubenstein to construct a 2-year binomial tree for the evolution of cash flows with a binomial period of 1.Assume the initial cash flow (CF₁)is $20 million,σ = 0.45,r = 0.13,g = 0.02,and the project lasts 2 years.What is the value of the project on the up node in year 1?

Accepted Answer

A)  $85 million 
B)  $185 million 
C)  $285 million 
D)  $385 million 
A)  $85 million 
B)  $185 million 
C)  $285 million 
D)  $385 million

Question 9

The price of oil is $115 per barrel.The effective lease rate and risk free rate are 3.0% and 4.0%,respectively.The constant cost of extraction is $85 per barrel and the volatility of prices is 15.0%.If an untapped well costs $2,100 to open and can produce indefinitely,what is the value of the unopened well?

Accepted Answer

A)  $724 
B)  $854 
C)  $913 
D)  $1,025 
A)  $724 
B)  $854 
C)  $913 
D)  $1,025

Question 10

Geek Is Us,Inc.may invest $8 million in an Alien Spectograph project.Annual costs and revenues,starting next year,are forecasted to be $3 million and $2 million growing at 0.0% and 4.0%,respectively.If the opportunity cost of capital is 6.0% and σ = 0.0,what is the investment trigger price?

Accepted Answer

A)  $20.95 million 
B)  $30.95 million 
C)  $40.95 million 
D)  $50.95 million 
A)  $20.95 million 
B)  $30.95 million 
C)  $40.95 million 
D)  $50.95 million

Question 11

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 12

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

Accepted Answer

First,the option is a call sin

Question 13

Walla,Inc.may invest $6 million in a Buffalo harvesting project.Annual costs and revenues,starting next year,are forecasted to be $1 million and $0.7 million,growing at 0.0% and 3.0%,respectively.If the opportunity cost of capital is 4.5%,what is the investment trigger price?

Accepted Answer

A)  $19.25 million 
B)  $21.25 million 
C)  $23.25 million 
D)  $25.25 million 
A)  $19.25 million 
B)  $21.25 million 
C)  $23.25 million 
D)  $25.25 million

Question 14

How are call and put options used to value starting,stopping,and restarting commodity extraction projects? Ask students to identify the calls and puts in each situation.

Accepted Answer

Call and put options can be used to valu

Question 15

An existing well is operating and the price of oil is $115 per barrel.The effective lease rate and risk free rate are 3.0% and 4.0%,respectively.The constant cost of extraction is $85 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)  $41 
B)  $48 
C)  $52 
D)  $59 
A)  $41 
B)  $48 
C)  $52 
D)  $59

Question 16

The current price of silver is $ 31.00 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 silver is a constant $25.00,what is the value of an option to wait and mine the silver later?

Accepted Answer

A)  $13.50 
B)  $14.50 
C)  $15.50 
D)  $16.50 
A)  $13.50 
B)  $14.50 
C)  $15.50 
D)  $16.50

Question 17

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 18

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

Accepted Answer

R & D options require continua

Question 19

What two components go into valuing an infinite commodity reserve?

Accepted Answer

First,we compute the value of

Question 20

The price of oil is $120 per barrel.The effective lease rate and risk free rate are 5.0% and 6.0%,respectively.The constant cost of extraction is $105 per barrel and the volatility of prices is 18.0%.What is the value of an option to defer extraction?

Accepted Answer

A)  $30.68 
B)  $32.08 
C)  $34.56 
D)  $38.34 
A)  $30.68 
B)  $32.08 
C)  $34.56 
D)  $38.34

Exam 17: Real Options

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

The current price per ton of iron ore is $145.00.The effective lease rate is 3.0% and the risk free rate is 4.5%.The cost to mine one ton of iron ore is $110.00 and constant.What is the trigger price at which we will mine the iron ore?

The current price per cord of lumber is $26.00.The effective annual lease rate is 2.0% and the risk free rate is 4.0%.The cost to harvest one cord is $20.00 and constant.What is the trigger price at which we will harvest the lumber?

What is the relationship,in general,between volatility and trigger prices,assuming constant costs?

The current price of silver is $32.00 per ounce.The effective lease rate and risk free rate are 3.0% and 4.0%,respectively.If the cost to mine one ounce of silver is a constant $25.00,what is the trigger price per ounce at which the silver will be mined?

Use Cox-Ross-Rubenstein to construct a 2-year binomial tree for the evolution of cash flows with a binomial period of 1.Assume the initial cash flow (CF₁)is $20 million,σ = 0.45,r = 0.13,g = 0.02,and the project lasts 2 years.What is the value of the project on the up node in year 1?

Geek Is Us,Inc.may invest $8 million in an Alien Spectograph project.Annual costs and revenues,starting next year,are forecasted to be $3 million and $2 million growing at 0.0% and 4.0%,respectively.If the opportunity cost of capital is 6.0% and σ = 0.0,what is the investment trigger price?

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

Walla,Inc.may invest $6 million in a Buffalo harvesting project.Annual costs and revenues,starting next year,are forecasted to be $1 million and $0.7 million,growing at 0.0% and 3.0%,respectively.If the opportunity cost of capital is 4.5%,what is the investment trigger price?

How are call and put options used to value starting,stopping,and restarting commodity extraction projects? Ask students to identify the calls and puts in each situation.

The current price of silver is $ 31.00 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 silver is a constant $25.00,what is the value of an option to wait and mine the silver later?

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?

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

What two components go into valuing an infinite commodity reserve?

The price of oil is $120 per barrel.The effective lease rate and risk free rate are 5.0% and 6.0%,respectively.The constant cost of extraction is $105 per barrel and the volatility of prices is 18.0%.What is the value of an option to defer extraction?

Introduction to Derivatives

An Introduction to Forwards and Options

Insurance, collars, and Other Strategies

Introduction to Risk Management

Financial Forwards and Futures

Commodity Forwards and Futures

Interest Rate Forwards and Futures

Swaps

Parity and Other Option Relationships

Binomial Option Pricing: Basic Concepts

Binomial Option Pricing: Selected Topics

The Black-Scholes Formula

Market-Making and Delta-Hedging

Exotic Options: I

Financial Engineering and Security Design

Corporate Applications

The Lognormal Distribution

Monte Carlo Valuation

Brownian Motion and Itos Lemma

The Black-Scholes-Merton Equation

Risk-Neutral and Martingale Pricing

Exotic Options: 2

Volatility

Interest Rate and Bond Derivatives

Value at Risk

Credit Risk

Filters

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