a) I dentify and explain the five variables that go into the black- Scholes opti

Question

a) I dentify and explain the five variables that go into the black- Scholes option pricing model and explain how movements in these variables affect the price of a put option. b) Acompany is condering a project. it has only 10% debt in its capital structure with a pre- tax cost of 8%. it has a beta of 1.4; the risk free rate is 5% and the equity risk premium is 6.5%. This would require an investment of $700,000. at the end of year 5 and this would produce a stream of cash flows with a present value of $650,000 at the end year 5. The volatility of the cash flows is 35%. The company considered this project to be a real option. a) Find the value of this real ( call ) option. b) Using the put- call parity, find the value of the put option.

Explanation / Answer

Alright the five inputs are as follows:

A Sixth input which was the dividend yield was also added later on. However that was only an extension of the original formula.

Now let's discuss the effect of movements in these inputs on the value of a put option

Hope that answers your queries.

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