. Continue with the power plant from the previous question, where again coal cur
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Question
. Continue with the power plant from the previous question, where again coal currently sells for $60 a ton but will sell for either $54 or $66 next month with equal probability. Now suppose coal can be stored for a month at the cost of $2 per ton. How would the new alternative of being able to buy coal at today’s prices and store it affect the amount the power plant would be willing to pay for an option to buy coal next month at today’s prices?
a.
Increase its willingness to pay for the option.
b.
Decrease its willingness to pay for the option.
c.
Lead it to never pay for the option.
d.
No effect. The new alternative of storing would never be chosen since it is worse than simply waiting and buying at next month’s uncertain price.
a.
Increase its willingness to pay for the option.
b.
Decrease its willingness to pay for the option.
c.
Lead it to never pay for the option.
d.
No effect. The new alternative of storing would never be chosen since it is worse than simply waiting and buying at next month’s uncertain price.
Explanation / Answer
It would have no effect on the willingness of the power plant to pay for the option to buy coal next month. This is so because the expected price and the current price both are equal to $60 and his there is no change in the price that is expected to be prepared for next month. Because there is no change in the expected price there will be no change in the willingness to pay. Correct option is option d.
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