Exam 3 Credit Risk PRM Handbook P. 318-320

[Anonymous]

Hi. Any idea how the risk-free formula is derived? In addition, I got a bit confused about the delta about shorting firm’s equity and longing government bonds and how does it really related to shorting firm’s asset. Is the formula III.B.5.7 a call option?
I think it is but why the textbook said it is a put option?

My understanding is that the -N(-d1) is the delta for a put option and the N(d1) is the delta of a call option. What exactly is -N(-d1)/N(d1)? Please help. Thanks.

[Philip Wong]

Exam 3 Credit Risk PRM Handbook P. 318-320

[Anonymous]

N(d1) is indeed the delta of the equity, seen as a call option on the assets.
As you want to construct a synthetic put by shorting N(–d1) of the assets of the firm, shorting -N(-d1)/N(d1) of the equity do the trick.

[Author]

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