Recall from your previous corporate finance studies. For a levered firm, firms assets are financed by equity and debt. That is, = + , where , & represents asset value, debt value and equity value at time . Suppose the firm makes no dividend payment and has a zero-coupon debt maturing at time . At maturity, if the value of the company asset is greater than the maturity value of the debt ( > ), the company will simply pay off the debt. Otherwise, the company will declare bankruptcy and debt holders will own the firm.

At maturity = : (i) From an equity holder perspective, describe a companys equity as a call option. In your answers, identify the underlying asset, strike price, maturity, and the payoff function of the call option.

(ii) From a debt holder perspective, describe a companys debt using a call option. In your answers, identify the positions that the debt holder takes on each asset (i.e. long or short?).

At time = 0: (iii) Suppose and are option prices (i.e. premium) for call and put options. Using the result from part (i) and put-call parity, describe a companys debt using a put option from a debt holder perspective. In your answers, identify the positions that the debt holder takes on each asset (i.e. long or short?).