Zero Coupon Bonds: Value of Option to Default on the Bonds

2. Assume your firm has zero coupon bonds maturing in 10 years with a face value of $183.75 million.

a) If the assets are worth $150 million, what is the value of the stocks and the bonds?
b) If the assets are worth $400 million, what is the value of the stocks and the bonds?
c) If the assets are worth $400 million, the standard deviation is 0.60 and the risk-free rate is the T-bond rate, what is the value of the option to default on the bonds? What is the value of the stockholders' call option? Use Black and Scholes to get the answer to part c.

Note: For parts a and b, assume the options would be exercised immediately. Be sure to label your answer.

Solution Preview

See the attached file.

2. Assume your firm has zero coupon bonds maturing in 10 years with a face value of $183.75 million.

a) If the assets are worth $150 million, what is the value of the stocks and the bonds?
Equity is a call option. If this option is exercised today, shareholders will receive their share only when after satisfying the financial claims of the debt holders.
The payoff to equity investors on liquidation are
= V - D if V > D
= 0 if V <D
where,
V = Value of the firm
D = Face Value of the outstanding debt ...

Solution Summary

Shows how to calculate the value of the option to default on the bonds, value of the stockholders' call option using Black and Scholes.

1.
Security: AAA AA A BBB BB
Yield (%) 6.2 6.4 6.7 7.0 7.5
Consolidated Insurance wants to raise $35 million in order to build a new headquarters. The company will fund this by issuing 10-year bonds with a face value of $1,000 and a coupon rating of 6.5%, paid semiannually. The above table shows the yield to maturit

Bonds can be issued at face value, at a discount or at a premium. What factor explains why bonds are issued at a discount?
A. The issuing firm is anxious to sell them.
B. The yield rate is less than thecoupon rate.
C. The yield rate is greater than thecoupon rate.
D. Thebonds are considered less risky than similar b

Dan is considering whether to issue coupon bearing bonds or zerocouponbonds. The YTM on either bond issue will be 7.5%. Thecoupon bond would have a 6.5% percent coupon rate. The company's tax rate is 35%. These are 20 year bonds.
2. How many of thecouponbonds must East Coast issue to raise the $50 million?
3. In 2

Which one of the following statements is most correct?
a. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required rate of return for a bond of similar risk is 8%.
b. Debentures generally have a higher yield to maturity relative to mortgage bonds.
c. If there are two bonds with equal

Fill in the missing items in the following table, using the Law of One Price. Assume all these bonds have the same risk, the yield curve is flat, and any coupon payments are paid annually.
Please see the attached file for full problem description.

Coupon interest rate on warrants. Please see the attachment.
Shearson PLC's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par valuebonds. Each bond will have attached 75 warrants, each exercisable into one share of stock at an exercise price of $47. Shearson's straight bond

The Jackson Company's bonds mature in 4 years, have a par value of $1000 and an annual coupon payment of $80. The market interest rate for thebonds is 9%. What is the price of these bonds?

Jia Hua Enterprises wants to issue sixty 20-year, $1,000 par value, zero-couponbonds. If each bond is priced to yield 7% , how much will Jia Hua receive ( ignoring issuance costs) when thebonds are first sold?
A. $18,880
B $12,393
C. $20,000
D. $15,505
E $11,212

My company's bonds are currently selling for $1,157.75 per $1,000 par-value bond. Thebonds have a 10% coupon rate and will mature in 10 years. What is the approximate yield to maturity of thebonds?