AK/ADMS 4580 3.0 - Take Home Final Exam - Question and Answer Forum
As questions are received about the exam, I will post the answers here.
Q: What is a Binomial lattice?
A: It is the diagram that you get using the binomial approach to options pricing that we did early in the course and again when we looked at the abandonment option.
Q: Do you prefer us to handwrite the exam or we can type it?
A: Either as long as it is neat. I do not want to have to struggle deciphering what you are trying to say.
Q: Should we assume annual or semi-annual compounding for bond calculations?
A: Actually, it is best to use continuous, for the sake of consistency with the option pricing calculations.
Q: Should we use 5% as the risk-free rate for all the questions, or only for the questions where specified?
A: I just re-read the exam, and I think I specified 5% in every question.
Q: At the end of Question 1, you asked us to compare values in b and c. Part c uses Black-Scholes, should we be calculating for part b using the binomial method, even though it is not going to be continuous? If so, do we calculate for the end of the sixth month, or calculate the option values at each month?
A: I want you compare the valuations that you get using the binomial lattice and the Black-Scholes. The lattice is an approximation, which will get better the more and smaller time intervals that are used.
Q: In question 4, it says, "The rolling stock is expected to produce annual cash flows of $8,000,000." Is that net profit or operating cash flow? Has it taken into consideration the salvage value of the equipment?
A: The "annual cash flow" is the net operating cash flow, and does not include any salvage value.
Q: In question 4, what is the difference between risk free rate and discount rate (25% and 5%)?
A: The 25% discount rate is the risk-adjusted discount rate for the project, whereas thet 5% risk-free rate assumes no risk.
Q: For Question 1 I calculated the option value using the method on pp 598-599 of the textbook, but I got option value is very small comparing with Black-Scholes. Is there something wrong?
A: As table 21.1 on page 600 demonstrates, there should not be an enormous difference in the binomial and Black-Scholes valuations.
Q: In Question 6, there is no mention of how many tonnes of ore in total are in the mine site. Do we need to know that in order to calculate the present value of net income from this project? Another way of asking this is "Shouldn't there be an estimated reserve or expected life of the mine?"
A: Actually for simplicity, I want you to assume a perpetual mine life.
Q: Where do we hand in the exam?
A: I am expecting it will be Room 282 Atkinson by 7:00 p.m. I have to give my ADMS3530 exam that evening, so I cannot set up a time for me to accept them personally.
If you need to get in touch, please send mail to amarshal@yorku.ca