Delta Importers has a pure discount loan with a face value of $180,000 due in one year. The assets of the firm are currently worth $215,000. The shareholders in this firm basically own a ________ option on the assets of the firm with a strike price of ________.

Question

Quizplus · Accepted Answer

The shareholders in this firm essentially own a call option on the firm's assets with a strike price equal to the loan amount due, which is $180,000. This is because if the assets' value exceeds the loan amount, shareholders can "exercise" their option by paying off the debt and retaining ownership of the company. If the assets' value is less than the loan amount, they can let the lender take the assets, similar to letting a call option expire worthless when the market price is below the strike price.

Delta Importers Has a Pure Discount Loan with a Face