Company BSM has total assets with a market value of $100 million financed by debt and equity. The annual volatility (standard deviation) of the total asset return is 30%. The debt is newly issued zero-coupon debt with a face-value of $60 million due for payment in one year. BSM’s assets have zero systematic risk. The risk free interest rate is 5% per annum with continuous compounding. Assume: there are no taxes; BSM will pay no dividends; the future value of BSM’s assets is log-normally distributed; the assets trade in a complete market; and lenders do not anticipate any change in management strategy . If BSM's management (unexpectedly) switch to a new strategy that doubles the total asset return volatility (without impacting total asset value or triggering any debt covenants), which of the following statements is/are true?     a. The market value of BSM's equity will go up   b. The market value of BSM's equity will go down   c. The market value of BSM's debt will go up   d. The market value of BSM's debt will go down   e. (a) & (d)   f. (b) & (c)

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Company BSM has total assets with a market value of $100 million financed by debt and equity. The annual volatility (standard deviation) of the total asset return is 30%. The debt is newly issued zero-coupon debt with a face-value of $60 million due for payment in one year. BSM’s assets have zero systematic risk. The risk free interest rate is 5% per annum with continuous compounding. Assume: there are no taxes; BSM will pay no dividends; the future value of BSM’s assets is log-normally distributed; the assets trade in a complete market; and lenders do not anticipate any change in management strategy .

If BSM's management (unexpectedly) switch to a new strategy that doubles the total asset return volatility (without impacting total asset value or triggering any debt covenants), which of the following statements is/are true?

 

  a.

The market value of BSM's equity will go up

  b.

The market value of BSM's equity will go down

  c.

The market value of BSM's debt will go up

  d.

The market value of BSM's debt will go down

  e.

(a) & (d)

  f.

(b) & (c)

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