Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Chapter 23, Problem 15PS
Default option valuation Look back at the first Backwoods Chemical example at the start of Section 23-1. Suppose that the firm’s book
The debt has a one-year maturity and a promised interest payment of 9%. Thus, the promised payment to Backwoods’s creditors is $1,090. The market value of the assets is $1,200 and the standard deviation of asset value is 45% per year. The risk-free interest rate is 9%. Calculate the value of Backwoods debt and equity.
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Suppose the real risk-free rate of interest is r*=4%�*=4% and it is expected to remain constant over time. Inflation is expected to be 1.60% per year for the next two years and 3.90% per year for the next three years. The maturity risk premium is 0.1×(t−1)%0.1×�−1%, where t� is number of years to maturity, a liquidity premium is 0.45%, and the default risk premium for a corporate bond is 1.40%.
The average inflation during the first 4 years is2.37% .
What is the yield on a 4-year Treasury bond?
4.30%
8.90%
6.75%
7.05%
What is the yield on a 4-year BBB-rated bond?
8.90%
7.50%
7.05%
8.45%
If the yield on a 5–year Treasury bond is 7.38% and the yield on a 6–year Treasury bond is 7.83%, the expected inflation in 6 years is . (Hint: Do not round intermediate calculations.)
Consider a long forward contract to purchase a coupon-bearing bond whose current price is $910. We will suppose that the forward contract matures in 9 months. We will also suppose that a coupon payment of $45 is expected after 4 months. We assume that the 4-month and 9-month risk-free interest rates (continuously compounded) are, respectively, 3% and 4% per annum. Explain how an arbitrageur can make profits from this scenario.
Suppose the real risk-free rate of interest is r=4% and it is expected to remain constant over time. Inflation is expected to be 1.60% per year
for the next two years and 3.90% per year for the next three years. The maturity risk premium is 0.1 x (t-1) %, where t is number of years to
maturity, a liquidity premium is 0.45%, and the default risk premium for a corporate bond is 1.40%,
The average inflation during the first 4 years is
What is the yield on a 4-year Treasury bond?
O 6.75%
O 8.90%
O 4.30%
O 7.05%
What is the yield on a 4-year BBB-rated bond?
O 7.50%
O 7.05 %
O 8.45%
8.90%
If the yield on a 5-year Treasury bond is 7.38% and the yield on a 6-year Treasury bond is 7.83%, the expected inflation in 6 years is
(Hint: Do not round intermediate calculations.)
Chapter 23 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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