New Wave Homes is a developer of planned residential communities. It has entered into an option contract with a land owner outside Sydney, NSW. It will pay the land owner $100,000 for the option to buy the land in two years at a price of $20 million. During that time New Wave will evaluate population and real estate trends in Sydney. Their plan is to buy the land if real estate prices in Sydney increase enough that developing the land would be worth more than the $20 million price. The $20 million purchase price resembles:

Question

Quizplus · Accepted Answer

The $20 million purchase price is the strike price of a call option on the land, as it is the price at which New Wave Homes can buy the land in the future.

New Wave Homes Is a Developer of Planned Residential Communities