QUESTION 10

1. You own a lot in Miami, Florida, that is currently unused. Similar lots have recently sold for $1.08 million. Over the past five years, the price of land in the area has increased 4 percent per year, with an annual standard deviation of 18 percent. A buyer has recently approached you and wants an option to buy the land in the next 12 months for $1.35 million. The risk-free rate of interest is 4 percent per year, compounded continuously. How much should you charge for the option?