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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 “state-price 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.

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