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Subordinate Debt

harsh092

New Member
In reading 20, Schweser quotes, "Because of the uncertainty associated with financial distress, the value of subordinate debt acts more like an equity security than a debt security. Therefore, when a firm is in financial distress, the value of subordinate debt will increase as firm volatility increases, while the value of senior debt will decline."

From BT notes, the value of a senior debt is V - c (V, F, T, t) and the value of subordinate debt is c (V, F, T, t) - c (V, F + U, T, t). Which explains why the above holds true mathematically, as the volatility increases the value of call options increases hence senior debt decreases in value. However, I am not able to make sense how subordinate debt will act both as debt and equity based on the market conditions. Could anyone explain this?
 
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