Your firm’s CEO has just learned about options and how your firm’s equity can be viewed...
Your firm’s CEO has just learned about options and how your firm’s equity can be viewed as an option. Why might he want to increase the riskiness of the firm, and why might the bondholders be unhappy about this?
Homework Answers
Option value increases with the riskiness hence equity value will increase with the riskiness so the manager would want to increase the riskiness of the firm as his compensation is tied to the equity.
Bond holders are unhappy because bond value=firm value-equity value. As firm value is constant, so when equity value increases bond value decreases.
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