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PriciyBquation

94 4
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i tr

i tr d
q
u d

tr d 0 by
o
g u d 0 by assumption

atr d u d
gas I
real prob u s
p
s
s II S

C Y EEG p C
i
Ca p G
9 Cd

IE G 9 Cat t g Cd
RISK ADJUSTED
PgRoBAB EA ECT
Fr
real probability risk free
rate ofretan
HI Cy
S C

I risk adjust
rate of return

eg Capri D rt be MRP

p
bi entpGg
aroleinpricinyi

RISK NEUTRAL PROBABILITY CRNp

E ECT
C
Fr
If asset is risk free

If marginal investor is risk neutral

is

ns
ur

E E r

E ECE E

a na risk aversion
g p
I

me

PVC E EG

Multiple Periods

ut s t
Tais
diues
S f uz des
d S
d lots
re l h I
1

de dz
Ith
9 9e Uz dz

ttr d
92 Uz d2

Two PeriodRxomple

BACKWARD INDUCTION

u Cu
Cad
i r i

Can Ct g Cud
q
cu
Etr

Su Bu I u's Beca
Du ud s Bu _Cad
Da s
14
c

American Options
17
GE
0

cf To
17
u KEEP his 6.30
o T
EXERCISE EARL no u s K
Go 55 5

I KEEP no
0
EXERCISE
d SIT
I
US 55 lo

6 30
no 233
01 KEEP
o

EXERCISE EARLY S K I
So 55 5

Call Non dividend


Thing American
paying stock
0 NEVER EXERCISE EARLY
o
European Coll Americal Call

Proof
E
CAt t Pet
t
St Buck
t
Pt s
t
k
p p p

qapi.EE EEE.Y

PEtSt
i
pre o

CE SEK 1Oet
P T
EXERCISE EARLY
KEEP

o CA C sincekeqeolenery
Pvt K k
t t
t T

wheredidweus.eu diridends

of Pat Cole
In our application
Pority cE PFtS PECK

WI dividends CE PftSt It 9K Ck

the end result CI Se Ie K


It 0

To

E It k se k

Pu
I
pA
pf
Liu. u

KEEP 0.62
no
T

RXERCISR EARLY K us _55 60 1

9.32
KRRP I
ii S L
55 45 40
EXERCISE Barry K 4

0.62 0.62 4 9 to
q
KEEP
6,45
to
K 55 50 51
EXERCISE EARLY 5
toes
0.62
I exercise
PA 6 y

no exercise early

Corporate Finance Example

A are
its
as

of payment over
Debt hes priority
Equity

has limited liability


Equity
t3 Asset Debt Equity
125 too 25

115 too is

90 90

80 80 0

Figureoutgbypn.ci

theunderlyi Uu 1zs

Auu zo fA4ua
And 115
129
uu
A
Ce guu Aaua
qa.tt
i
1 r
I 005
les
t r
4120
Anu A y
g a

Anfa Afd
Debt Noninal

It AT N D Dt N

AT N O DT At
If
T
Payoff

i
Equity
o ET AT N
IS AT N

IS A TCN o ET 0

Eq CAT a

of

So Dt AT ET At CAT a

Ate Max CAT N 0

At min C ATTN 0
min At At N
AH
g Dy minCN A

o Dp N maxCN AT

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