medium · Corporate Credit Analysis

Using the Merton structural model intuition, if a company's equity volatility (sigma_V) increases significantly while its debt level stays the same, what happens to its credit risk?

1. Credit risk increases because the value of the 'risky put' held by creditors becomes more valuable.
2. The company's rating will automatically be upgraded, as volatility signals stronger growth.
3. There is no change because the debt principal amount stays fixed no matter how volatile assets get.
4. Credit risk decreases because higher volatility makes the equity holders' call option more valuable to own.

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