You own a plot of land near the airport that is currently worth $9.5 million. Local commercial real estate markets are quite volatile. One year from today the land has a 55% probability of being worth $12 million and a 45% chance of being worth $8.5 million. The airport is considering an expansion and would like you to sell them the right (but not the obligation) to purchase your land for $10 million one year from today. If the one-year government bond yield is 7%, what is a fair price for the right? (Hint: why doesnt the probability of up vs. down enter into the equations for the solution?

What is Su?

What is Sd?

What is the risk neutral probability of the up state, p?

What is the price of the option? (Note: the answer is in millions)