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September 2007 qtn 5

L

Lewin

Member
Solution assumes a call option with strike price k=10 for equity value
the question states that asset value is expected to grow at 10% p.a,shouldnt this affect(increase?) asset value including strike price value at wound up date??
 
The question says the ZCB has "nominal value £10m".

This means the bondholders are entitled to receive £10m at maturity. This is not affected by the growth of the firm's assets (although the growth will affect the company's ability to pay what's due).

The shareholders have a call option on the company's assets at 10 years. They can pay the bondholders £10m and will then own all the company's assets by themselves.

So it's correct to have a strike price of £10m.
 
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