Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
Download
Standard view
Full view
of .
Look up keyword
Like this
0Activity
0 of .
Results for:
No results containing your search query
P. 1
Black-Scholes Option Pricing Assigment

Black-Scholes Option Pricing Assigment

Ratings: (0)|Views: 1 |Likes:

More info:

Published by: Information should be FREE on Oct 07, 2010
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

05/12/2014

pdf

text

original

Page 1 of 3
CORPORATE FINANCE
(DR. GERALD POLLIO)
DATA
Lag time of the project
= 2 Years
Dividend Yield or Net production revenue
each yearδ
= 5% of reserves
Current value of the asset: As the current value of the asset must reflect the loss of
production revenues during the delay or the lag time, value of the asset will be
discounted back at dividend yield (δ) for 2 years. This reflects the loss of cash flow
during developmental period. Therefore current value of oil fieldo
Sis;
o
S= $12 x 50,000 x(
)2
05
.
0
1
+
= $ 544.22 millions
K= Exercise price = Developmental cost = $ 600 millions
T= Time to expiration
= 20 years
R= Risk free interest rate
= 8%
2
σ= Variance
=3%
SOLUTIO
The firms that make natural resource investments have the option to leave the
investments untouched if the price of the resource declines and to exploit them fully if
the price rises. Therefore, extracting the reserves make sense only if the value of
reserves exceeds the development cost. Therefore, a natural resource investment can
be viewed as a call option where the underlying asset is the reserve and the value of
the reserve depends on the quantity and price of the natural resource.
Underlying offshore oil property offers production revenue of 5% of the 50 million
barrels of reserves ever year which is the dividend yield of the asset. As payment of
dividend reduces the assets’ price; the call option under consideration will become
less valuable due to 5% dividend yield on its .
Typical Black- Scholes Model applies to the assets which do not pay dividends over
their life, therefore it do incorporate the effect of dividend yield on interest rate as
well as loss of revenue at dividend yield for the duration of developmental work.
Following adjusted Black and Scholes Model will incorporate this. (Bodie, et al; 2008
p 758), (Mun, J, 2002), (Wikipedia link provided)
BLACK SCHOLES MODEL
For non-dividend paying option the call value is calculated by following expression.
)
(
)
(
2
1
0
d
K e
d
S
C
rT
=
Page 2 of 3
The term
)
(1
0
d
S
represent the present value of the cash inflows of investment,
therefore in order to accommodate the dividend yield (know asδ) which decreases
the value of investment, we further discount
0
Sto
T
e
δ
[note that
T
e
δ
is almost
equal to 1-δT, so the value of dividend will be approximately δT0
S]. (Bodie, et al,
2008)
Hence,
0
S
T
e
S
δ
0
we get
)
(
)
(
2
1
0
d
K e
d
e
S
C
rT
T
=
δ
……….. Equation 1
Also, in case of non-dividend paying model,
1
dis
T
T
r
K
S
d
σ
σ
×
+
+
=
2
ln
2
0
1
To accommodate the dividend yield, we will have to deductδ from risk free rater to
reflect the reduction in the carrying cost of the asset.
Replacingr
δ
r
, we get
1
dfor a dividend paying options we get;
T
T
r
K
S
d
σ
σ
δ
×
+
+
=
2
ln
2
0
1
………. Equation 2
T
d
d
σ
=
1
2
…….… Equation 3
CALCULATIOS
Using equations 1, 2, and 3, we get
1
d=
20
*
03
.
0
20
)
203
.
0
05
.
0
08
.
0
(
60022
.
544
ln
×
+
+
1
d= 1.0359
and

You're Reading a Free Preview

Download
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->