The Options Theoretic approach to calculating economic capital considers the value of capital as being equivalent to a call option with a strike price equal to:

The Options Theoretic approach to calculating economic capital considers the value of capital as being equivalent to a call option with a strike price equal to:
A . The notional value ofthe debt
B . The market value of the debt
C . The value of the firm
D . The value of the assets

View Answer

Answer: A

Explanation:

The Options Theoretic approach to calculating economic capital is a top-down approach that considers the value of capital as being equivalent to a calloption with a strike price equal to the notional value of the debt – ie, the shareholders have a call option on the assets of the firm which they can acquire by paying the debt holders a value equal to their notional claim (ie the face value of the debt).Therefore Choice ‘a’ is the correct answer and the other choices are incorrect.