Zero-coupon risky debt value in a firm is equal to
A) Risk free debt plus a call option on the firm's assets.
B) Risk free debt minus a put option on the firm's assets.
C) Equity value minus a call option on the firm's assets.
D) Firm value minus a put option on the firm's assets.

Question

Quizplus · Accepted Answer

Zero-coupon means that there are no periodic interest payments and the bond is sold at a discount to its face value. In the case of risky debt, the value of the bond is equal to the risk-free debt minus a put option on the firm's assets. The put option represents the bondholder's right to sell back the bond to the firm in case of default. Therefore, option B is the correct choice. The other choices involve call options which are not typically associated with debt instruments.

Zero-Coupon Risky Debt Value in a Firm Is Equal to