Question
Recall from your previous corporate finance studies. For a levered firm, firms assets are financed by equity and debt. That is, = + , where
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 = :
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?).
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