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# A piece of land has a 30% chance of being located over an oil reserve, in which case it is going to be worth 100M. If there is no oil, the land is worth 30M. You are offered an option to buy the land at 40M after inspecting it and ascertaining if there is oil. How much are you willing to pay for this option?

27

i think the answer should be 18 million. the payoff of the option is 60m or 0. 60*0.3=18

Daniel on

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Daneil, Why the payoff of the option is 60m or 0? I think the payoff is either 0 or 10M

Jay on

2

9million. Your payoff if there is oil (30%) there is 100million - the 40million you soend -X(the amount you paid to check if there was oil). Then if you find no oil you wont buy it but you have already spent X to check. So spending X has a payoff equation: X=.3(100m-X)+.7(-X)

Cal on

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This is a very basic options question, of course. Not being too familiar with options, I did not follow that until it was too late and the interviewer had corrected me. They mislead you slightly by first asking you for the fair value of the piece of land and by asking the question in a fairly convoluted way.

Anonymous on

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20 Million

Unlucky Star on

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Expected value = 0.3(100m) + 0.7(30m) = 30m + 21m = 51m => option price = 51m - 40m = 11m No?

Nick on