Under the contingent claims approach, credit risk is modeled as the value of a put option on the value of the firm's assets with a strike equal to the face value of the debt and maturity equal to the maturity of the obligation. The cost of credit risk is determined by the leverage ratio, the volatility of the firm's assets and the maturity of the debt. Cash flows are not a part of the equation. Therefore Choice 'a' is the correct answer.
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