Suppose That the Asset Value of a Firm Evolves According

question 1

Multiple Choice

Suppose that the asset value of a firm evolves according to a lognormal diffusion,as in Merton (1974) .The current value of the firm's assets is $100 million,and its volatility is 24.24%.Suppose too that the firm has only one issue of debt outstanding: zero-coupon debt with a maturity of three years,and a face value of $70 million.Finally,suppose that the risk-free rate of interest is 4% (continuously-compounded terms) for all maturities.What is the risk-neutral probability of the firm defaulting at maturity of the debt?

• A)17.12%
• B)19.23%
• C)20.02%
• D)21.22%

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Definitions:

Pleiotropy

A genetic phenomenon where a single gene influences multiple phenotypic traits, which can be seemingly unrelated.

Affects

Refers to the experience of feeling or emotion, especially as it influences behavior and thoughts.

Traits

Characteristics or features of organisms passed from parents to offspring through genes.

Heterozygous

Referring to having two different alleles of a particular gene, one inherited from each parent.