In structural models, the debt holder’s position is equivalent to owning a risk-free bond, ZCB, and selling a call option on the company’s assets with a strike price equal to par value of the bond.
Explanation: If the value of the assets < value of the bond, the assets will not be called away. If the value of the assets > value of the bond (strike of the call), the assets will be called away and the bond holder will be paid the face value of debt (strike of the call).
Shouldn’t it be selling a put option? What is the correct strategy? Also, what about equity holders’ strategy?
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