State the generalised law of one price, Finance Basics

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Question:

a) An oil well now produces 75000 barrels per year. The well will produce for 21 years more, but production will decline by 3.7% per year. Oil prices however, will increase by 2.5% per year. What is today's price of 1 barrel of oil if the present value of the well's production is $50 M? The discount rate is 9.7% compounded continuously.

b) State the generalised law of one price.

c) Show that an option on an index will never be more expensive than the cost of a corresponding collection of options on the individual securities.


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