The value of a risk-free bond can be duplicated by combining a risky bond with a _____ option on the assets of the firm with a _______ maturity date and a strike price _____ to the face value of the bond.
A) Put; matching; equal to
B) Call; matching; equal to
C) Put; later; lower than
D) Call; later; equal to
E) Put; shorter; greater than

Question

Quizplus · Accepted Answer

A risk-free bond's value can be replicated by combining a risky bond with a put option on the firm's assets. The put option should have a matching maturity date and a strike price equal to the face value of the bond. This allows the bondholder to sell the assets for the face value if the firm defaults, effectively making the bond risk-free.

The Value of a Risk-Free Bond Can Be Duplicated by Combining