Explanation:
The subordinated debt's payoff is equivalent to a portfolio of two call options on the firm's assets. A long call option with strike price (the face value of senior debt) and a short call option with strike price (the combined face value of senior and subordinated debt). Thus, its value is given by .
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Q.4358 A publicly traded firm has issued senior debt (denoted D) with a face value of F and a current value of A. It has also issued subordinate debt (denoted SD) with a face value of U and a current value of B. Both debts are scheduled to mature in exactly T years. The firm has also issued ordinary equity (denoted S). If the total value of the firm is V, which of the following expressions gives the payoff for subordinate debt?
A
B
C
D