Situations involve step functions

Reference no: EM13995739

1. Simulation is one way to find an expected value for Janet Dawes's problem as diagrammed in Figure 11.3. How could you construct a discrete approximation that would at least provide an approximate expected cost for Supplier 2?

2. What other real-world situations involve step functions like the one that Janet Dawes faces?

3. An investor has purchased a call option for 100 shares of Alligator stock and intends to hold it until the day the option expires, at which time he will sell it if he can. The op tion is worth nothing on its expiration date unless the price of Alligator stock is more than $45 per share. For values of the stock greater than $45, the option will be worth 100(Share Price - $45). The reasoning behind this value is that the call option permits the option's owner to purchase 100 shares at $45 per share. Thus, if the share price is greater than $45, then the option owner could buy the shares and immediately resell them at the market price, pocketing the difference. Of course, the investor is uncertain about Alligator's eventual share price on the exercise date, but his uncertainty can be modeled using a normal distribution having mean $45.50 and standard deviation $5.00. Construct a simulation to estimate the expected value of the option on the exer cise date.

Reference no: EM13995739

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