adeeplytroubledsteelcompanycanbeestimatedusingthe
average variance in firm value of all traded steel companies.
Maturity of the Debt
Mostfirmshavemorethanonedebtissueontheirbooks,and
much of the debt comes with coupons. Since the option
pricing model allows for only one input for the time to
expiration,wehavetoconvertthesemultiplebondissuesand
couponpaymentsintooneequivalentzerocouponbond.We
can use one of the following approaches to estimate maturity:
- One solution, which takes into account both the
couponpaymentsandthematurityofthebonds,isto
estimatethedurationofeachdebtissueandcalculate
aface-value-weightedaverageofthedurationsofthe
differentissues.Thisvalue-weighteddurationisthen
usedas ameasure ofthetime toexpiration ofthe
option. - Anapproximationistousetheface-value-weighted
maturityofthedebtconvertedtothematurityofthe
zero coupon bond in the option pricing model.
Face Value of Debt
Whenadistressedfirmhasmultipledebtissuesoutstanding,
wehavethreechoiceswhenitcomestowhatweuseasthe
face value of debt:
1.Wecouldadduptheprincipaldueonallofthedebtofthe
firmandconsiderittobethefacevalueofthehypothetical
zerocouponbondthatweassumethatthefirmhasissued.
Thelimitationofthisapproachisthatitwillunderstatewhat