When a Firm in Financial Distress Accepts Very Risky Projects

question 23

Multiple Choice

When a firm in financial distress accepts very risky projects, the stockholders benefit at the expense of the bondholders. In terms of option theory, the gain to the stockholders occurs because:

• A) the stock is a put option on the firm's assets, and risky projects decrease the exercise price of the option.
• B) the stock is a put option on the firm's assets, and risky projects increase the exercise price of the option.
• C) the stock is a call option on the firm's assets, and risky projects increase the volatility of those assets.
• D) the stock is a call option on the firm's assets, and risky projects decrease the volatility of those assets.

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Definitions:

Stimulus Discrimination

Stimulus Discrimination is the ability to differentiate between one stimulus and another, especially in the context of learning and behavior.

Spontaneous Recovery

The phenomenon where a learned behavior resurfaces after a period of non-exposure to the associated stimulus, demonstrating the persistence of memory over time.

Pavlov

Refers to Ivan Pavlov, a Russian physiologist known for his work in classical conditioning, particularly using bells to induce salivation in dogs.

Spontaneous Recovery

Describes the sudden reappearance of a previously extinguished response after a period of no exposure to the conditioned stimulus.