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Dear John!
Could you please help me with defining an exercise price for an option to expand. For example, in 3 years time a company may invest k100$ and it will bring k150$ in the same year. cost of capitl is 10%.
Then we say that Pa (price of underlying) will be PV of k200$. So: 200/(1,1)^3=150,26
And Pe will be k150$.
I can’t understand why we don,t use a PV of 150? as investment will be in three years time, so i feel that we compare not “like with like”. Could you please help me to clarify.
Thank you,
AnnaI am a bit puzzled where you are getting all the figures from – particularly the $200K.
You will have to give me a bit more information.Dear John!
I’m sorry for misleading you.. studing too hard to pass this paper:)
For this example Pa will be PV of k150$. And Pe will be k150$. Why do we not discount the investment that will happen in three years to get Pe?
thank you,
AnnsThe reason is that the e term in the equation for the option price is effectively taking care of the discounting 🙂
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