Real Options and binomial method

Question 1

What are some examples of real options?

Answer 1

Timing, expansion, abandonment, flexibility, growth.

Question 2

How does the binomial method value options?

Answer 2

Build a tree → calculate payoffs → discount back using risk-neutral probabilities.

Question 3

How could binomial thinking help business decisions?

Answer 3

Model different future paths → assign payoffs → weight by probability → discount to present → choose best.

Question 4

What are two methods of risk-neutral valuation?

Answer 4

Replicating portfolio (no-arbitrage) and risk-neutral probability method.

For American options → must also check for early exercise.