{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Solution 7 - Fin 448 Fixed-Income Securities Homework...

Info icon This preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Fin 448: Fixed-Income Securities Homework Solution 7 Wei Yang 1 Risk-neutral pricing (1.1) 800 = 900 π * 1 + 60(1 - π * 1 ) π * 1 = 0 . 880952 900 = 1000 π * 2 + 120(1 - π * 2 ) π * 2 = 0 . 886364 (1.2) The senior bond gets $100 at the end of year 2, no matter which state realizes. With a 0 risk-free rate, the price of the bond at the end of year 1 is also $100 under no bankruptcy. At the end of year 1 if the firm goes bankrupt, the senior bond gets $60. Hence, the price of the bond today is 100 π * 1 + 60(1 - π * 1 ) = 95 . 2381 (1.3) At the end of year 2 when assets value is $1000, the junior bond gets $100; when assets value is $120, it gets $20. The price of the junior bond at the end of year 1 is 100 π * 2 + 20(1 - π * 2 ) = 90 . 9091 At the end of year 1 if the firm goes bankrupt, the junior bond gets 0. Hence, the price of the junior bond today is 90 . 9091 π * 1 + 0(1 - π * 1 ) = 80 . 0866 (1.4) At the end of year 2, the value of the stocks is $800, so the price is $80 per share. At the end of year 1, 900 - 100 - 90 . 9091 100 = 7 . 09091 Finally, the stock price today is 800 - 95 . 2381 - 80 . 0866 100 = 6 . 24675 1
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
2 Corporate bond (2.1) s = π * D L * = 5% × 40% = 2% (2.2)
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern