An agricultural engineer from Whitehall, Wisconsin has discovered a new method o

Question

An agricultural engineer from Whitehall, Wisconsin has discovered a new method of milk extraction that causes less swelling to a cow's udders, and therefore each cow has a faster recovery time between milkings. *Use a whole page for this, in landscape layout. a. If all dairy farms in a perfectly competitive milk market adopt this technology, graph the short run effects for both individual firms and the market overall. b. In words and graphical illustration (use the graph from part a), indicate the long-run effects of this technological advance.

Explanation / Answer

76.Solution:

The payoff from the put option is $0 if the stock price rises and $25 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations:

$0 = ($32 × x) + (1.02 × y)

$25 = ($5 × x) + (1.02 × y)

x = –0.93 shares of stock

y = $29.05 of risk-free bonds

The value of the option is the value of the replicating portfolio:

(–0.93 × $29) + ($29.05) = $2.20

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