Equity and debt as options

Research output: Chapter in Book/Report/Conference proceedingEntry for encyclopedia/dictionary

Abstract

This chapter explains how debt and equity contracts can be considered as options on the firm's assets. Treating interest and principal repayments on a debt instrument as the equivalent of the strike price on an option contract allows for a more detailed understanding of the payoffs to debt and equity investors conditional on future cash flows from the firm's assets. This treatment also allows for an improved understanding of the incentives of equity investors to take on financial risk by gearing up their firms in a limited liability environment for equity investors.
Original languageEnglish
Title of host publicationWiley Encyclopedia of Management
Subtitle of host publicationFinance
PublisherJohn Wiley & Sons Inc.
ISBN (Print)9781118785317
DOIs
Publication statusPublished - 21 Jan 2015

Keywords

  • limited liability
  • equity
  • debt
  • bankruptcy

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  • Cite this

    McColgan, P. (2015). Equity and debt as options. In Wiley Encyclopedia of Management: Finance John Wiley & Sons Inc.. https://doi.org/10.1002/9781118785317.weom040007