The future value of debt is either or whichever is

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Unformatted text preview: e can also apply this approach to valuing the firm. Today’s value of the firm is found as 94 By value additivity, today’s value of the corporate debt, Pricing Derivatives , equals: Alternatively we can calculate the bond price directly from its cash flows at time 1. The future value of debt, , is either or , whichever is lower: With the calculated bond price, the theoretical yield on the debt is which is far above the riskfree rate of 10%. The debt issue looks like a junk bond. We will return to issues related to corporate debt in chapter 16. References Original References The use of option theory to interpret equity values goes back to at least Black and Scholes (1973) Textbook References A standard reference on derivatives is Hull (2008). 10.3 Interpreting Equity as an Option 95 Problems 10.1 MLK [4] The current price of security MLK is 100. Next period the security will either be worth 120 or 90. The risk free interest rate is 33.33%. There are two digital options traded. One pays $1 if MLK is at 120 next period. This option is trading at . The other pays $1 if MLK is at 90 next period. This option is trading at . 1. Price a put option on MLK with exercise price . 2. Price a put option on MLK with exercise price . 3. Price a call option on MLK with exercise price . 4. Price a call option on MLK with exercise price . 96 Pricing Derivatives...
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This document was uploaded on 02/15/2014 for the course BEM 103 at Caltech.

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