Hi everyone,

Hope you’re all plugging away as hard as I am.

My question concerns the following: V(risky debt) = V(risk free debt) - V(put option on company)

Now, I realize that V(risky debt) < V(risk free debt) since there is no risk to the investment and I understand that the put option can be correctly priced using the BSM. The V(put option on company) is a reflection of the probability of default that investors bear the risk for should volatility increase or should market conditions worsen.

I’m having a hard time just understanding the theory behind how selling a put option would account for the difference in risky debt. I was hoping that somebody could put this in layman’s terms for me.

Thanks in advance.