Lesson 5 of 5 · 11 min
Put–call parity and the value of the firm
With zero-coupon debt of face value D, shareholders hold a call on the firm's assets and debtholders hold risk-free debt minus a put, so .
In short
- Firm value equals equity plus debt: . At maturity T the debt's face value D is due.
- If (solvent), debtholders get D and shareholders get . If (insolvent), debtholders get and shareholders get 0.
- Shareholder payoff is a call on firm value with exercise price D: unlimited upside, limited downside.
- Debtholder payoff is risk-free debt plus a sold put on firm value: upside capped at D.
- Parity gives . The put's value reflects the credit spread; it rises as insolvency becomes more likely.
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