The value of a risk-free bond can be duplicated by combining a risky bond with a _____ option on the assets of the ﬁrm with a _______ maturity date and a strike price _____ to the face value of the
Bond.

Question

Quizplus · Accepted Answer

The value of a risk-free bond can be duplicated by combining a risky bond with a Put option on the assets of the firm with a matching maturity date and a strike price equal to the face value of the bond. This will provide the holder of the bond with the option to sell the underlying assets at a fixed price, ensuring they receive the face value of the bond regardless of any decrease in the value of the assets. A Call option would not be appropriate as it provides the holder with the option to buy the underlying assets, rather than sell them, and a later or shorter maturity date or a strike price lower or greater than the face value of the bond would also not provide the desired risk-free result.

The Value of a Risk-Free Bond Can Be Duplicated by Combining