CFA Practice Question

There are 252 practice questions for this study session.

CFA Practice Question

According to the option analogy, owning a company's equity is equivalent to:
A. owning a riskless debt and selling a European put option.
B. owning a riskless debt and selling a European call option.
C. owning a European call option.
Explanation: In structural models, holding the company's equity is economically equivalent to owning a European call option on the company's assets because payoff of a company's equity is the same as the European call option on the company's assets with strike price K and maturity T.

User Contributed Comments 2

User Comment
ma3212 I don't see how answer C follows put-call parity. The european call position has asymmetric returns (ie. if the equity price drops then the value of the call will go to zero), so it's not equivalent to holding just equity. An equity position is equivalent to Long Call + Short Put + Zero Coupon at Strike. What am I missing here?
truss88 imagine two euro calls, one with a strike price of 0 and another with a strike price of K. both are worthless if the underlying falls below a threshold. remember that bondholders get paid first, so if the company's liabilities exceed its assets then the equity becomes worthless, just like an out of the money call on the expiration date.
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