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53212
50 0.6
rf 10%
D 80 200
EQ (BV) 20 120
100Δ-c 100
mkt value of EQ 33.84127
70
0
Δ= 0.923077
A firm having present market value S0=100 and face value of debt 80. The stdev risk of firm value is 40%.
maturity and firm can be liquidated at any time before that time. The situation can be thought of as CALL
the firm with strike price K=80. Assume the risk free rate as 10% per annum.
S0 (present value of firm D+E) 100 value of the firm at present since it is in co
K (face value of debt) 50 claim of debt holders, if the value of equit
T (yrs to maturity for debt) 10 any time within the maturity of the bond/
risk free rate (p.a.) 10.00%
Volatility 40.00% calculated from the history
d1 1.9710
d2 0.7061
N(d1) 0.9756
N(d2) 0.7599
C (Option value of equity at present) 83.5856 value of equity now, as equity holders are
Present Market value of debt 16.4144
NOTE: As we increase the time to maturi
Interest rate on debt/ yield on debt 11.14%
dev risk of firm value is 40%. The debt has 10 years to
on can be thought of as CALL OPTION on EQUITY of
5.9e^(10r)=20 ln(20/5.9)/10=r
quity now, as equity holders are holding the option of getting the residual if positive or walking away if loss
uity will have a option value even if the value of firm falls below face value of outstanding debt
m will be viewed as troubled by investors, accountants and analysts, but that does not mean that its
worthless.
ep out-of-the-money traded options command value because of the possibility that the value of the
g asset may increase above the strike price in the remaining lifetime of the option, equity will
value because of the time premium on the option (the time until the bonds mature and come due)
ossibility that the value of the assets may increase above the face value of the bonds before they
.
t explain why stock in firms, that are essentially bankrupt, still has value, there there are some
them
A firm having present market value S0=100 and face value of debt 80. The stdev risk of firm value is 40%.
maturity and firm can be liquidated at any time before that time. The situation can be thought of as CALL
the firm with strike price K=80. Assume the risk free rate as 10% per annum. The firm stockholders want t
that has negative NPV and is highly risky. The stdev changes to 50%.
S0 (present value of firm D+E) 100 NPV value of the firm at present since it is in co
K (face value of debt) 80 0 claim of debt holders, if the value of equit
T (yrs to maturity for debt) 10 any time within the maturity of the bond/
risk free rate (p.a.) 10.00%
Volatility 50.00% calculated from the history
d1 1.5642 NOTE:
d2 -0.0170 The value of EQUITY increases even after
firm becomes more risky (higher stdev) t
N(d1) 0.9411 but for a given stdev risk, with decreasin
N(d2) 0.4932 This might explain why debt holders try t
of EQUITY increases even after taing a very risky project with negative NPV (risk taking) and if the
mes more risky (higher stdev) the option value of equity rises further.
given stdev risk, with decreasing NPV of new vantures, firms option value of equity falls.
t explain why debt holders try to have restrictions covenants.
VOLATILITY
40% 50% 60% 70% 80% 90% 100%