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Investing Specialists

The Market for Perpetual Options

Current market conditions have stocks displaying their option characteristics.

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Given the negative press derivatives have received recently, it appears that the financial world has forgotten that a common stock is actually a financial derivative of the value of the underlying company.

Capital Structure And Derivatives
The market value of a company is simply the sum of the market value of all of the financial obligations of the company: debt obligations, preferred stock, equity obligations, and any other obligations the company issues. The reasoning behind this is simple: if I want to buy a company in its entirety, I need to pay off all of the claim holders in order to have complete claim to the earnings and cash flow generating power of the company.

If the company can't make its payments to debtors, suppliers, or other claimants on the company, the company files for bankruptcy. If the value of the company in bankruptcy is less than the face value of the debt, the equityholders get nothing, and the debtholders get paid all of the value of the company. However, if the company doesn't declare bankruptcy, and the value of the company skyrockets, the debtholders do not participate in the upside of the share price above the face value of the debt.

Philip Guziec does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.