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Expected Value

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C1. Assume that you work for Bank of North America and that you have made a $20 million loan to Kinkus Publishing, which must be repaid at the end of this year. Kinkus has undertaken a major expansion, ant eh value of its assets when the loan comes due is expected to be either $25 million (the "bad" outcome) or $50 million (the "good" outcome). These two outcomes are equally likely.
a. What repayment will you receive under each of the two outcomes? What is the expected value of these repayments?
b. Now assume that Kinkus has issued $15 million of new debt to another party, which is also due at the same time that owed to you. Kinkus distributed the proceeds of this debt to its stockholders, so its assets and their projected values at the end of the year are unchanged. If Kinkus is unable to pay all its debts when they come due, the loans are of equal priority, so both lenders will receive the same fraction of the amounts owed them.
What repayment will you now receive under each of the two outcomes? What is the expected value of these repayments?

Solution Preview

a) Kinkus can repay the 20M under both scenarios as the value of its assets is greater than 20M under both the good and bad ...

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The solution provides an excellent response to the question being asked. It goes into a considerable amount of detail and explains the concepts being asked very well.

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