Use the following information to answer the question(s) below.
Galt Industries is trading for $20 per share and has 25 million shares outstanding. Galt Industries has a debt-equity ratio of 0.4 and its debt is zero coupon debt with a ten year maturity and a yield to maturity of 8%.
-Which of the following best describes Galt's debt using a put option?

Question

Quizplus · Accepted Answer

A) MV of equity = $20 share x 25 million shares = $500 million
Since the D/E ratio = .4 => Debt/$500 = .4 => Debt = .4(500) = $200 million in debt.
The shareholders are entitled to any residual value after the debt of $200 million is fully repaid. Therefore the strike price is $200 million. Since risky debt = risk-free debt - put option on firm assets we know that we need to be long the risk free debt and short the put.

Use the Following Information to Answer the Question(s) Below