Option pricing theory and credit risk


The bondholders pay the short-sellers through losses on their loan. Skip to main content. If the company gets into trouble credit related then the value of the assets will decline and the bond holders will get less at maturity i.

If the company gets into trouble credit related then the value of the assets will decline and the bond holders will get less at maturity i. The market short-sellers in stock market do that. But why the payoffs to the stockholders resemble those of a call option? I am very much confused!

Equity or stock is equal to a call bought on the assets A with face value of liabilities or bonds F as strike price. AMA Mar 28th, If the company gets into trouble credit related then the value of the assets will decline and the bond holders will get less at maturity i.

If the assets of the company are highthe put option expires worthless and bondholders get the entire face value of their loans back at maturity. You can find a lot of information about it on the web. Be prepared with Kaplan Schweser.

But why the payoffs to the stockholders resemble those of a call option? If the company gets into trouble credit related then the value of the assets will decline and the bond holders will get less at maturity i. They have the right to exercise the option - which since the call is out of option pricing theory and credit risk money - they do not exercise.