For the equity of a firm to be considered a call option on the firm's assets, the firm must:
A) Be in default.
B) Be leveraged.
C) Pay dividends.
D) Have a negative cash flow from operations.
E) Have a negative cash flow from assets.

Question

Quizplus · Accepted Answer

The equity of a firm can be considered a call option on the firm's assets when the firm is leveraged, meaning it has debt. This is because equity holders have a claim on the assets of the firm only after debt obligations have been met, similar to how a call option gives the holder the right, but not the obligation, to buy an asset at a certain price.

For the Equity of a Firm to Be Considered a Call