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    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 Preview

    Given that,
    Net asset value, A=$140 million
    Debt value, B=$100 million
    Volatility, ...

    Solution Summary

    Black-Scholes-Merton model is applied to this case.