Merton model

Imagine you have a piggy bank and you want to save some money in it. But, there's a chance that someone might steal your money or the piggy bank might break, and you'll lose all of your savings.

In the same way, companies also save money to use it to grow their business, but there's a chance that they might not be able to pay back their debts and go bankrupt.

This is where the Merton Model comes into play. This model helps people estimate the chance that a company might go bankrupt. The model takes into account how much debt a company has, the value of its assets, and how volatile, or unstable, its stock price is.

Think of it like a pie chart – the Merton Model slices the pie into different pieces and calculates the probability of the company going bankrupt based on the size of the different pieces. If a company has a lot of debt and its assets' value is low, the Merton Model would show a higher chance of it going bankrupt.

This helps people who invest in the stock market or lend money to companies make informed decisions. By using the Merton Model, they can get a better idea of which companies are more likely to pay back their debts and grow their business, and which ones might not be able to.