Question

Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $117 per barrel and the land is believed to contain 436,000 barrels of oil. If found, the oil would cost $80 million to extract. Treasury bills that mature in one year yield a continuously compounded interest rate of 4 percent and the standard deviation of the returns on the price of crude oil is 50 percent.

Use the Black-Scholes model to calculate the maximum bid that the company should be willing to make at the auction.

Answer 1

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