A firm has assets of $16.4 million and 2-year, zero-coupon, risky bonds with a total face value of $7.4 million. The bonds have a total current market value of $7.1 million. The shareholders of this firm can change these risky bonds into risk-free bonds by purchasing a ________ option with a 2-year life and a strike price of ________ million.

Question

Quizplus · Accepted Answer

To protect the bondholders against the risk of default, shareholders can buy a put option, allowing them to sell the bonds at a predetermined price if the firm's value falls below a certain level. The strike price should match the face value of the bonds, $7.4 million, to ensure bondholders can be paid the full amount they are owed, hence option E is correct.

A Firm Has Assets of $16