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Question regarding Black Scholes

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Question regarding Black Scholes

  • This topic has 3 replies, 2 voices, and was last updated 4 years ago by John Moffat.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • October 27, 2020 at 5:07 pm #593282
    thorif
    Participant
    • Topics: 4
    • Replies: 3
    • ☆

    Hello. It’s quite difficult for me to identify Pa and Pe values in questions.

    In the MMC question from BPP Revision Kit, I used the present value of cash flows from the project as Pa. But in another question (Furlion) I knew the present value of cash flows from the project, but I had to undo the discounting. I had to use the cash flow value (not its present value) a Pa. I don’t understand why this is.

    MCC : Pa = 38.75
    Furlion : Pa = 10.68

    Any guidelines on how to identify these values from questions? Also, why was Pa different for these two questions (one discounted, other one not discounted)

    October 28, 2020 at 8:06 am #593324
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    In Furlion, the question says that the expected NPV of the expansion is $0.

    Since the expansion will involve expenditure of $15M in 3 years time, then the PV of the cash receipts from the expansion must also equal $15M in 3 years time (so that the NPV is zero).

    Pa is the PV ‘now’ and so the $15M needs to be discounted for 3 years, which gives $10.68M

    October 28, 2020 at 8:19 am #593329
    thorif
    Participant
    • Topics: 4
    • Replies: 3
    • ☆

    Alright. Another question popped into my head.

    Shouldn’t Pe, which is 15 also be discounted since its happening after 3 years?

    October 28, 2020 at 8:34 am #593337
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54700
    • ☆☆☆☆☆

    No.

    As I explain in my free lectures, the last term in the Black Scholes equation (the one with Pe and ‘e’ in it) is effectively discounting Pe on a continuous basis (instead of year by year as we usually do elsewhere). So we don’t need to discount it again 🙂

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