The value of a government guarantee of a bond equals the value of a put option on the firm's assets.

Question

Quizplus · Accepted Answer

A government guarantee on a bond provides protection to the bondholders if the issuing company defaults on its payments. This guarantee essentially functions as a put option for the bondholders, as they have the right to sell the bond back to the government at a predetermined price. Therefore, the value of the government guarantee is equal to the value of a put option on the firm's assets.

The Value of a Government Guarantee of a Bond Equals