Question

In: Accounting

9. A firm has assets of $16.4 million and 2-year, zero-coupon, risky bonds with a total...

9. A firm has assets of $16.4 million and 2-year, zero-coupon, risky bonds with a total face value of $7.4 million. The bonds have a total current market value of $7.1 million. The shareholders of this firm can change these risky bonds into risk-free bonds by purchasing a ____ option with a 2-year life and a strike price of _____ million.

Multiple Choice

A. call; $7.1

B. call; $7.4

C. put; $16.4

D. put; $7.1

E. put; $7.4

Solutions

Expert Solution

Whenever a company has any risky asset and it assesses that it may not be able to realize all the money receivable from that asset, the company hedges its position and safeguards its assets by purchasing a call or put option so that uncertain market in the future does not have ant effect on its assets.

In the given case scenario, the firm has an asset of $16.4 Million and zero coupon risky bonds having a face value of $ 7.4 Million.

The firm wants to hedge its position and want to convert zero coupon risky bonds into risk free bonds.

Put Option= Option to sale an asset at some agreed amount in the future date.

Call Option= Option to purchase an asset at some agreed amount in the future date.

The company fears that it may not realise from risky bonds.

So the company should purchase a PUT option equalling to the face value of Zero coupon bonds i.e. $7.4 Million.

Therefore correct answer is option E. put; $7.4

ekkarill92 answered 2 years ago
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