Explain the Brennan-Schwartz method for valuing mines.

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The Answer is Brennan and Schwartz developed a method for valuing mines that takes into account the owner's options to reduce and increase production,but does not require the observation of the market price of an option to purchase the mineral being mined.The inputs used in their valuation method are the current forward price of the mineral,the volatility of the price of the mineral,and the risk-free rate of interest.Although the Brennan and Schwartz method is complex,it can be approximated with the binomial approach.This technique,used in valuing derivative assets,assumes that the future price movements of the underlying asset follow a binomial process in which the price of the asset takes on one of only two possible values after one time period: a high value or a low value.The derivative asset also takes on only one of two possible values at the end of the time period.Thus,the future value of the mine can be tracked by a portfolio of two traded investments,which,according to the no-arbitrage assumption,implies that the value of the mine is simply the cost of the tracking portfolio.

Explain the Brennan-Schwartz Method for Valuing Mines