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Question - J&R Construction Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $61 million to construct. Due to low demand for office space in the downtown area, such a building is worth approximately $59 million today. If demand increases, the building would be worth $63.4 million a year from today. If demand decreases, the same office building would be worth only $57 million in a year. The company can borrow and lend at the risk-free annual effective rate of 2 percent. A local competitor in the real estate business has recently offered $760,000 for the right to build an office building on the land.
Required - What is the value of the office building today? Use the two-state model to value the real option.
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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