Zero-coupon risky debt value in a firm is equal to
A)Risk free debt plus a call option on the firm's assets.
B)Risk free debt minus a put option on the firm's assets.
C)Equity value minus a call option on the firm's assets.
D)Firm value minus a put option on the firm's assets.

Question

Quizplus · Accepted Answer

The value of zero-coupon risky debt in a firm can be conceptualized as the value of risk-free debt minus the value of a put option on the firm's assets. This is because the risky debt holders are essentially selling a put option on the firm's assets to the equity holders, which gives the equity holders the right to "sell" the firm to the debt holders (by defaulting) if the firm's value falls below a certain level (the debt's face value).

Zero-Coupon Risky Debt Value in a Firm Is Equal to