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Fourer Corp. has a zero coupon bond that matures in five years with a face value of

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Fourer Corp. has a zero coupon bond that matures in five years with a face value of $90,000. The current value of the company’s assets is $74,000, and the standard deviation of its return on assets is 50 percent per year. The risk-free rate is 6 percent per year, compounded continuously.
a. What is the value of a risk-free bond with the same face value and maturity as the current
bond?
b. What is the value of a put option on the firm’s assets with a strike price equal to the face value of the debt?
c. Using the answers from (a) and (b), what is the value of the firm’s debt? What is the continuously compounded yield on the company’s debt?
d. Assume the company can restructure its assets so that the standard deviation of its return on assets increases to 60 percent per year. What happens to the value of the debt? What is the new continuously compounded yield on the debt? Reconcile your answers in (c) and (d).
e. What happens to bondholders if the company restructures its assets? What happens to shareholders? How does this create an agency problem?
Strike Price
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity. Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the... Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest...
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Corporate Finance Core Principles and Applications

Corporate Finance Core Principles and Applications

ISBN: 978-0077905200

3rd edition

Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe, Bradford

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A put option is a financial contract that gives the owner the right, but not the obligation, to sell an underlying asset, such as a stock or a commodity, at a predetermined price, known as the strike price, on or before a specific date, known as the expiration date. Put options are used by investors as a form of insurance against a decline in the value of the underlying asset. If an investor expects the value of an asset to fall in the future, they can purchase a put option on that asset. If the value of the asset does fall, the put option will increase in value, allowing the investor to sell the asset at the higher strike price. For example, if an investor owns 100 shares of a stock that is currently trading at $50 per share, they may purchase a put option with a strike price of $45 and an expiration date three months in the future. If the stock price falls to $40 before the expiration date, the investor can exercise the put option and sell their shares for $45 each, even though the market price is only $40. This would allow the investor to limit their losses. It\'s important to note that purchasing a put option involves paying a premium to the seller of the option, and the investor can lose the entire premium if the price of the underlying asset does not decline as expected. Put options are just one type of financial derivative and should only be used by experienced investors who understand the risks involved.

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