Question #16 - Reading 28 Credit Analysis Models

Reading: Reading 28 Credit Analysis Models

PDF File: Reading 28 Credit Analysis Models.pdf

Page: 7

Status: Correct

Correct Answer: A

Shared Context

- Based on Exhibit 1 and a par value of $100, the expected loss on the Alligator bond in year 2 is closest to: A) $0.5718. B) $0.5737. C) $0.5789.

Question

In relation to structural models, the instrument that Monera cannot recall is most likely a:

Answer Choices:

A. long put with a strike price equal to the value of assets

B. short put with a strike price equal to the value of debt

C. short put with a strike price equal to the value of assets

Explanation

Debtholders are viewed as having a long position in a riskless bond that pays X at time T and simultaneously a short position in a European put option on company assets with a strike price of X (equal to the face value of debt). In other words, debtholders receive either the face value of debt if the company survives or X – (X – A) = A if the company defaults (where A = the value of the assets of the company).

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