Question 1 Biotechnology firm Infinite Life Unlimited ( ILL ) is waiting for FDA approval for its new miracle drug that can slow* the aging process . The company is currently trading at $ 2.53 per share . If the FDA approves the drug , its shares* could reach $200 per share . If unsuccessful , the firm's intellectual property would be worthless but the firm* would still have cash reserves of 50. 45 per share . You have heard from a knowledgeable friend that the FDA decision may come out as soon as next Friday which is Several months ahead of schedule . Unfortunately you have no idea whether it will be an approval or a rejection . The following options are currently on the market :" Option TYPE Strike Expiry Price ILUCO 25 Call 52.50 Two months $1.90 ILUCIOD Call 510.00 Two months 50. 25 ILUPO 25 Put 52.50 Two months 51. 85 ILUIPODS Put 50.50 Two months 50.19 (a) Design a long option strategy that will make as much money as possible regardless of whether the FDA decision is an approval or rejection , assuming that it is announced next Friday ."You have $200,000 that you can spend in any way that you like . There are position limits which prevent you from holding more* than 150 , 000 of any option . State the size of each option position that you are purchasing . Compute the profit that you will make if the FDA approves or alternatively rejects the drug . 16 ) Design an option Strategy , which can be long and / or short , which will make as much money as possible regardless of which way the FDA decision goes or even if the FDA does not make a decision for three* months . Again you have a maximum of $200, 000 cash and the position limits are $ 150 , 000 on any option . You can assume there are no margin requirements on writing options . State the size of each option* position that you take and whether it is long or short . Compute the profit that you will make if the FDA approves the drug , rejects the drug , or does not make any decision prior to expiry . Question 2 Your neighbour offers you the option to harvest 10%` of her pine plantation every year for the next five years if you the work and split the sale proceeds with her . You estimate that her plantation currently has about 10 , 000 tonnes of timber and that it will grow at an average of 10%' per annum but with a standard deviation of 5%6 . The price of timber is currently $100 per tonne and you expect this will grow at 3%' per annum . All transactions occur* at the end of each year including harvesting and the sales . Your discount rate is zero . You value your time and costs at $50, 000 per year . ( a ) Determine the value to you of this option if you harvest for the next five years . 16 ) Determine the value to you of this option if you can walk away after any year in which your share of the earnings is not at least $50, 000 . You will need to compute the expected cash flow each year after* adjusting the probabilities of reaching each node
