Can credit risk be embedded in a stock’s price?
Say you have company A that has a decent chance of defaulting and entering bankruptcy due to insolvency issues. The unsecured debt of company A is subsequently trading at a discount to account for the credit risk. Is that credit risk ever reflected in the company’s stock price (given that once company A goes bankrupt, all equity value gets wiped out)?
Equity value becomes the option value of either going bust or recovering a certain value.
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