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HI,
Been practicing using BSOP to value real options and this has led me to question why we use the NPV of the cashflows for PA but we don’t discount the PE value for the price of exercise, despite making the assumption that the option is a european style option and is thus only exercisable on a future set date- thus in real terms the value for PE will also be affected by the time value of money and makes sense (for me atleast) to discount this too..
Can’t get my head around this, wondering if you could explain the reasons behind it..
In the BSOP formula, Pe is multiplied by e^(-rt).
This is effectively discounting Pe (it is discounting it on a continuous basis as opposed to just yearly discounting as we do in ordinary NPV questions).
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