I. T he V aluation of C orporate S ecurities I n a recent paper Black and Scholes [ 3 ] presented an explicit equilibrium model for valuing options. In this paper they indicated that a similar analysis could potentially be applied to all corporate securities. In other papers, both Merton [ 8 ] and Ross [ 11 ] noted the broad applicability of option pricing arguments. At the same time Black and Scholes also pointed out that actual security indentures have a variety of conditions that would bring new features and complications into the valuation process. Our objective in this paper is to make some general statements on this valuation process and then turn to an analysis of certain types of bond indenture provisions which are often found in practice. Specifically, we will look at the effects of safety covenants, subordination arrangements, and restrictions on the financing of interest and dividend payments. Throughout the paper we will make the following assumptions: a1 ) Every individual acts as if he can buy or sell as much of any security as he wishes without affecting the market price. a2 ) There exists a riskless asset paying a known constant
The Journal of Finance – Wiley
Published: May 1, 1976
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