Posted: September 18th, 2022

The option pricing model has many uses. This question demonstrates its application in calculating

The option pricing model has many uses. This question demonstrates its application in calculating the market value of a company ’ s debt capital. Assume that a company has risky zero-coupon 65 bonds with a market value B (the debt ’ s face value is D ), which are guaranteed by the company ’ s assets.
The option pricing model has many uses. This question demonstrates its application in calculating the market value of a company ’ s debt capital. Assume that a company has risky zero-coupon 65 bonds with a market value B (the debt ’ s face value is D ), which are guaranteed by the company ’ s assets.
The option pricing model has many uses. This question demonstrates its application in calculating the market value of a company ’ s debt capital. Assume that a company has risky zero-coupon 65 bonds with a market value B (the debt ’ s face value is D ), which are guaranteed by the company ’ s assets. The debt (including interest payments) is paid at the end of period T , and so bankruptcy claims can be made only at the end of the period. As discussed in chapter 14, if the market value of the company ’ s shares is S , then the company ’ s market value is V = S + B . In question 10 of chapter 18, we demonstrated that buying a share S (or for our present purposes, any risky asset) and a put option on that share (or that risky asset), and selling a call option on that share (or risky asset), where both options have the same exercise time T and where the exercise price is equal to the share price S = X , we will obtain the same result as holding a risk-free zero-coupon bond D where S + P − C = D . Using the end-of-period payment schedule for shareholders and bondholders, and for scenarios where asset values at the end of the period are either higher or lower than the debt V ≤ D ; V > D , demonstrate that the following: a. A leveraged company ’ s shares can be considered an option on that company ’ s value (Black and Scholes 1973). In other words, the share price S is actually a call option on the company ’ s assets V left over at the end of the period (after payment of the company ’ s debt). b. Using part (a) above and the equation S + P − C = D , demonstrate that the risky debt ’ s value B is equivalent to the risk-free debt ’ s value D plus the sale of a put option on the company ’ s assets

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The option pricing model has a wide range of applications. This question explains how it can be used to calculate the market value of a company’s debt capital. Assume a firm owns hazardous zero-coupon 65 bonds with a market value of B (the debt’s face value is D) that are guaranteed by the company’s assets.
The option pricing model has a wide range of applications. This question explains how it can be used to calculate the market value of a company’s debt capital. Assume a firm owns hazardous zero-coupon 65 bonds with a market value of B (the debt’s face value is D) that are guaranteed by the company’s assets.

The option pricing model has a wide range of applications. This question exhibits its use in determining the market value of a company’s stock.

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