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<h2 class="hd hd-2 unit-title">Origins of Option Pricing Theory</h2>
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<h3 class="hd hd-2">Origins of Option Pricing Theory</h3>
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<h2 class="hd hd-2 unit-title">What is an Option?</h2>
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<h2 class="hd hd-2 unit-title">Exercise: What is an Option?</h2>
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Exercise: What is an Option?
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<p>Imagine you are the CFO of ABC Pharmaceuticals, and you have just financed a Phase 3 clinical trial for a new migraine medication at a cost of $200 million. If the trial is successful, the market launch for the new therapy would cost $100 million, and would occur at the end of the clinical trial in 3 years.</p>
<ol>
<li>If we think of the possibility of launching the new therapy as an option, is it a call or a put?
<p><div class="wrapper-problem-response" tabindex="-1" aria-label="Question 1" role="group"><div class="choicegroup capa_inputtype" id="inputtype_e112052bde34457f9686160188bda624_2_1">
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<div class="indicator-container">
<span class="status unanswered" id="status_e112052bde34457f9686160188bda624_2_1" data-tooltip="Not yet answered.">
<span class="sr">unanswered</span><span class="status-icon" aria-hidden="true"/>
</span>
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</div></div></p></li>
<li>
What is its strike price? (<i>Note</i>: Your answer should be expressed in units of millions of dollars.)
<p><p style="display:inline">$</p><div class="inline" tabindex="-1" aria-label="Question 2" role="group"><div id="inputtype_e112052bde34457f9686160188bda624_3_1" class=" capa_inputtype inline textline">
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<span class="trailing_text" id="trailing_text_e112052bde34457f9686160188bda624_3_1"/>
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<span class="sr">unanswered</span><span class="status-icon" aria-hidden="true"/>
</span>
<p id="answer_e112052bde34457f9686160188bda624_3_1" class="answer"/>
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</div></div><p style="display:inline">million</p></p>
</li>
<li>
What is its time to maturity?
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<h2 class="hd hd-2 unit-title">Exercise: Valuation of Options</h2>
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Exercise: Valuation of Options
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<p>Imagine you are the CFO of ABC Pharmaceuticals, and you have just financed a Phase 3 clinical trial for a new migraine medication at a cost of $200 million. If the trial is successful, the market launch for the new therapy would cost $100 million, and would occur at the end of the clinical trial in 3 years. In addition, depending on economic market conditions, the present value of future commercialization profits could either go up 50% to $750 million or down 50% to $250 million. The 3-year annualized risk-free rate is 4% per year.
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<li>Ignoring the scientific risk associated with the trial (which is assumed to be independent of the market risk), what is the value of the project? (Note: Your answer should be expressed in units of millions of dollars.)
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<li>Now suppose the probability of success of the trial, due to scientific risk, is 60%. What is the rNPV of the project? Assume the project has no value if it fails. (Note: Your answer should be expressed in units of millions of dollars.)
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<h2 class="hd hd-2 unit-title">Interactive: Black-Scholes Formula</h2>
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<p>The graph below calculates the price of a call option using the Black-Scholes formula. What happens to the option's price if you change the volatility of the underlying stock? What happens if you change the option's maturity or strike price? </p>
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