Explanation:
Statement A is correct - In the Merton model, the payment to debt holders can indeed be viewed as the payoff of a riskless bond plus a put option on the value of the firm. This is because:
Statement B is incorrect - The Merton model assumes continuous asset price movements following geometric Brownian motion and cannot capture sudden jumps or surprises that lead to unexpected defaults.
Statement C is incorrect - The Merton model only considers default at the maturity of debt, not early defaults before maturity.
Statement D is incorrect - While firm value estimation can be challenging, this is not a fundamental limitation of the Merton model itself, but rather a practical implementation issue.
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In the following things about Merton model, which of the statement is true?
A
In Merton model the payment to debt holder can be seen as the payoff of a riskless bond plus a put on the value of the firm.
B
The sudden surprise (a jump), leading to an unexpected default can be captured by the model.
C
The model can take into account the default prior to the maturity of debt, when a borrower claims so.
D
The value of the firm is difficult to pin down cause the market-to-market value of debt is often unknown.
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