[Verse 1]
There's a company with assets worth a hundred million strong
But they borrowed sixty million, debt payment won't be long
When the deadline comes tomorrow, will they pay or will they fall?
Here's the secret that we're learning, equity's a special call
[Chorus]
Merton model, option thinking
Equity's a call that's blinking
Asset value, debt's the strike
Pay or walk away alike
Call option on the firm's true worth
Default risk we can unearth
Merton model shows the way
Will the company survive the day?
[Verse 2]
Picture shareholders as buyers of a call option so bright
Firm assets are the underlying, shining in the market light
The strike price is the debt amount they promised they would pay
If assets beat the debt value, shareholders win the day
[Chorus]
Merton model, option thinking
Equity's a call that's blinking
Asset value, debt's the strike
Pay or walk away alike
Call option on the firm's true worth
Default risk we can unearth
Merton model shows the way
Will the company survive the day?
[Bridge]
When assets fall below the debt
Shareholders just walk away yet
Limited liability means
They lose their stake but nothing more it seems
But when the assets rise up high
Above the debt that made them cry
They exercise and pay it all
Then keep the rest from their smart call
[Verse 3]
This model helps us see the risk of companies that might default
By viewing equity as options, we can find each hidden fault
Volatility of assets matters, time to maturity too
Just like any call option, these factors guide us through
[Final Chorus]
Merton model, option thinking
Equity's a call that's blinking
Asset value, debt's the strike
Pay or walk away alike
Call option on the firm's true worth
Default risk we can unearth
Merton model shows the way
Credit risk we measure today
[Outro]
From Black-Scholes to credit models
Merton bridged the gap with style
Now we see that equity holders
Hold a call option all the while