Abstract: To solve the financing problem of SMEs, a new financing model has been introduced, which is the equity-for-guarantee swap (EGS). In this paper, the optimal investment and financing decisions of a firm that uses a financial derivative, equity-for-guarantee swap (EGS) are studied, in an emerging market. With this swap, the entrepreneur obtains a loan from a banker guaranteed by an insurer, after granting the insurer a fraction (guarantee cost) of his equity.
First, the price of equity and debt and the guarantee cost are provided based on equilibrium pricing rules. Second, in a real-options framework, the algebraic equations about the optimal investment timing and the optimal production scale respectively are derived. Finally, the optimal size of the loan is analyzed. In this paper, the analytical solutions of the pricing of the firm's securities and the guarantee cost are firstly obtained. Then, the relationships among the optimal investment timing and the optimal investment scale and the optimal financing structure are determined. In the end, the advantage of this financing model is shown. Economic analysis indicates that there is an U-shaped relation between the optimal production scale and the project risk. When the risk is smaller, the enterprises will accelerate the investment and increase the proportion of debt financing. Compared with the enterprises with all-equity financing and the enterprises with no financing constraints, the new financing model significantly increases the production scale of the firm. In contrast to the enterprises with all-equity financing, the optimal production scale and the optimal investment threshold all increase with the project volatility. The results in the paper have an import influence on the investment and financing decisions of small and medium-sized enterprises. At the same time, the comparative research between the option-for-guarantee swap and the equity-for-guarantee swap will be promoted in the future.

Key words: small and medium-sized enterprises, the investment timing, the production scale