For the equity of a ﬁrm to be considered a call option on the ﬁrm's assets, the ﬁrm must:

Question

Quizplus · Accepted Answer

A call option gives the holder the right, but not the obligation, to buy an underlying asset at a predetermined price (strike price) within a specific time period. In this analogy, the underlying asset would be the firm's assets. For the equity of a firm to be considered a call option on the firm's assets, it must have leverage, meaning that the firm has debt. This is because debt holders have a prior claim on the firm's assets, creating a situation where the equity holder's position can be viewed as a call option on the firm's assets. None of the other choices are relevant for this concept.

For the Equity of a ﬁRm to Be Considered a Call