The value of debt, under a constant value of the firm, is a decreasing function of the value of equity. The value of equity, in this case, is the value of a call option on the value of the firm. All else being held constant, the value of debt decreases when the firm's volatility or interest rate rises, when the principal of the debt amount declines, and when the time to maturity of the debt increases.

Things to Remember

• Debt and equity are two main sources of financing for a firm.
• Debt holders have a higher priority claim on the firm's assets in case of bankruptcy compared to equity holders.
• The value of debt is influenced by factors such as interest rates, time to maturity, and the firm's volatility.
• Debt can be issued in the form of bonds, loans, or other debt instruments.
• Debt financing typically involves regular interest payments and repayment of the principal amount at maturity.