PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 23, Problem 11PS
Summary Introduction
To determine: The variables required to use to determine the risk-neutral probability that a company default on its debt.
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describe and compare alternative ways to estimate the probability of company defaulting on its debt obligations. Explain the difference between real-world and risk-neutral estimates
If the credit quality of the issuer falls sharply, what is your main concern?
a.The share price.
b.The volatility of the underlying
c.The default risk.
d.A rise in risk free interest rates
Give typing answer with explanation and conclusion
In considering the market-based approach to measuring credit risk, choose all statements that are correct:
a) The Merton model is useful to price defaultable debt as long as the underlying company has exchange-traded stocks.
b) In the Merton model, the only unknown parameter is the volatility of firm equity
c) In the Merton model, the only unknown parameter is the volatility of firm value, which comprises equity and debt.
d) CDS spreads cannot be used to imply default probabilities because recovery rates are variable
Chapter 23 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 23 - Expected yield You own a 5% bond maturing in two...Ch. 23 - Bond ratings In February 2018, Aaa bonds yielded...Ch. 23 - Bond ratings It is 2030 and the yields on...Ch. 23 - Prob. 4PSCh. 23 - Default option Other things equal, would you...Ch. 23 - Prob. 6PSCh. 23 - Prob. 7PSCh. 23 - Default option Digital Organics has 10 million...Ch. 23 - Prob. 9PSCh. 23 - Prob. 10PS
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- What is the value of Ls stock for volatilities between 0.20 and 0.95? What incentives might the manager of L have if she understands this relationship? What might debtholders do in response?arrow_forwardfinancial risk management fill in the blacks with correct answer. Interest rate risk is the potential for investment (....loss/gain..........). that result from a change in the interest rates. If interest rate (rise/fall)..., for instance, the value of the bond or fixed-income instrument will decline.arrow_forwardIf a firm increases its financial risk by selling a large bond issue that increases its financial lewverage explain this assumption?Also what is the relationshipbetween risk and return. Explain with examples bold examples.arrow_forward
- A corporate bond's return becomes less uncertain as default risk increases. True or False. Explain your answerarrow_forwardConsider the following scenario analysis A. Is it reasonable to assume that treasury bonds will provide higher returns in recessions than in booms? B. Calculate the expected rate of return and standard deviation for each investment. C. What investment would you prefer?arrow_forwardSuppose company Z is already in financial distress and the equity holders are very close to default. Suddenly there is a shock that causes an increase in the standard deviation of the return on company Z's assets. Which of the following correctly describes the new situation faced by company Z? A) Debt value will increase with the shock and equity holder are more likely to default. B) Equity value will increase with the shock and equity holder are less likely to default. C) Both Debt value and equity value will increase but the likelihood of default is unchanged. D) Both debt value and equity value will decrease and the likehood of default will increase.arrow_forward
- Which of the following businesses are most exposed to interest rate risk? * A. A company with a high equity to debt ratio B. A company with a large amount of floating rate debt C. An al-equity company D. An investment company with an investment portfolio that matches its investment horizon.arrow_forwarda.Distinguish between systematic and unsystematic risk and explain the significance of the distinction portfolio analysis b. Describe the assumption in CAPM analysis that corporate debt as a zero beta value c. Based on both the CAPM and Modigliani- Miller proposition (11), explain the support of relevant equations, how changes in the debt equity ratio can change a firm's equity betaarrow_forwardIs default risk premium likely to be pro-cyclical (i.e., increasing during economic expansion) or counter-cyclical (i.e., increasing during the economic recession)? Why?arrow_forward
- Please explain it why choosing option correct and wrong # Which of the following best describes interest rate risk? The risk that credit ratings will change, affecting the value of assets and liabilities The risk that banks will not be able to meet their liquidity requirements None of the above The risk that interest rates will rise or fall, affecting the value of assets and liabilitiesarrow_forwardWhich asset below is generally the most suitable benchmark measure of the risk-free return? Treasury bills Small stocks Long-term government bonds Non-investment grade bonds Common stocksarrow_forwardQUESTION Hedging is a risk management strategy that is used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities. In effect, hedging is a transfer of risk without buying insurance policies. REQUIRED: Discuss the importance of hedging to the financial risk manager Are there any downside to hedging?arrow_forward
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