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Options and real options for a gold mine

In a gold mine, the price of gold is a major determinant of the value of the project.

a. When the price of gold drops, what real option in the mine may be exercised?

b. When the price of gold rises, what real option in the mine may be exercised??

c. If the volatility of gold increases and all else remains the same, is it more or less likely for a closed gold mine to reopen??

d. If the volatility of gold increases and all else remains the same is it more or less likely for an open gold mine to close??

e. Given that gold production has both fixed and variable costs, which of these is more important in assessing real option value?
What are the options analogs to these two types of costs??

Please answer each question in detail

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Answer:
(a) As we know that the mining companies has right but no obligation to start mining. Suppose S is the payoff for the mining company and X is the total cost of mining. In the situation when the price drops the pay off for the mining company earning drops and comes to a situation when the company has a zero payoff so in this situation the company should stop mining if the profit payoff is
0 if and only if S≤X
This indicates that either the company can reduce ...

Solution Summary

This solution explores options and real options with regards to a gold mine.

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