In terms of relating options to the value of the firm, the equity of the firm can be viewed as:
A) a call option on the firm with the exercise price equal to the promised payments to the bondholders.
B) a call option on the firm with the exercise price equal to the firm's after-tax cash flow.
C) a put option on the firm with the exercise price equal to the promised payments to the bondholders.
D) a put option on the firm with an exercise price equal to the firm's after-tax cash flow.

Question

Quizplus · Accepted Answer

Equity can be viewed as a call option on the firm's assets, with the exercise price being the promised payments to the bondholders. If the firm's value exceeds the promised payments, equity holders benefit, similar to how a call option gives the right to buy at a predetermined price.

In Terms of Relating Options to the Value of the Firm