As CFA book says, holding the company equity is equivalent to holding a call option on company asset with exercise price as maturity value of debt because either you get excess of asset (if debt is paid) or zero.
If this situation is analogus to holding a call option that what is the equivalent to call premium that holder has to pay to seller?
Can anyone help explaining what sort of call premium the equity holder has paid and to whom?
It would seem the premium would be the market price per share, no?
hmm and then who is the receiver of this option premium? debt holder? Debt holder themselve lended money to company so doesn’t seems to be receiver of the premium.
The receiver is the company issuing that equity during its IPO and subsequent offerings. The value of that equity is traded on the open market and increases in value.
Its basically just saying that the stock holders receive the value of the company after equity holders, so its basically Enterprise Value - Debt > 0 and that number is book value of equity that equity holders own. Or EV - D < 0 and the “option” is worthless.
The bondholders sell the option; the shareholders buy the option.
It seems to me that the premium is the interest that the shareholders pay to the bondholders.
After thinking it over more, I absolutely agree with S2000.
Thanks S2000. Now it all fits into equation. Equity holder pay premium (in terms of interest on debt), option seller (lenders) takes risk and sells option on Asset. If asset goes up then option seller just take exercise price and relieve claim on asset else they take less valued asset.
I get lucky sometimes.