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Unformatted text preview: . Figure 10.1 provides a graphical illustration of the payoﬀ pattern.
Hence, today’s value of equity ( ) is the value of a call option written on the
assets of the ﬁrm (whose value equals ), with strike price equal to . 10.3 Interpreting Equity as an Option 93 Figure 10.1 Tomorrow’s value of equity
. as a function of the value of the ﬁrm Value of Equity
✻
✲ Example
Consider the PQZ company. The future value of the ﬁrm,
, is either
or
. Inclusive of interest payments, the ﬁrm’s debt amounts to:
. This
amount is due next period. The price of a digital option that pays 1 in the state when
equals 1,000 and zero otherwise is 0.45. The riskfree rate is 10%.
We will use the by now familiar techniques to value the current value of equity. Use the
digital option price to ﬁnd the “stateprice probabilities”
and .
Since there are only two states, and the probabilities have to sum to one,
Therefore, the value of equity, , is found as: In fact, w...
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This document was uploaded on 02/15/2014 for the course BEM 103 at Caltech.
 Fall '08
 Lehmann,B

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