The valuation of credit guarantees by compound options

From a financial point of view, loan guarantees can be seen as put options on parts of the company's value. Usually, loan guarantees are valued by the model by Merton. This model, however, assumes that there are neither interest payments nor repayments of the loan itself (be it guaranteed or not) before the time to maturity. Our paper presents a model that allows the valuation of loan guarantees regardless of the terms and conditions of interim payments. The suggested model is applied to loans with different conditions of repayment. Furthermore, we investigate how changes in the parameters affect the risk adjusted premia of loan guarantees.