Black-Scholes-Merton model
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Company ABC currently has net assets worth $140 million and has issued $100 million in debt in the form of a zero-coupon bond that matures in one year. By looking at the equity market, we estimate that the volatility of the asset value is 30%. The risk-free interest rate is at 5%. Please find:
1) Equity value of the company according to Black-Scholes-Merton model?
2) What's the credit spread (yield over risk free rate) of the firm debt?
3) What's the 1-year risk-neutral default probability of the company?
4) If the firm defaults, what would be the recovery value according to Merton's model?
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Solution Summary
Black-Scholes-Merton model is applied to this case.
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Answer:
Given that,
Net asset value, A=$140 million
Debt value, B=$100 million
Volatility, ...
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- MBA, Indian Institute of Finance
- Bsc, Madras University
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