Solution 7

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

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Unformatted text preview: 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 2 Corporate bond...
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This note was uploaded on 10/06/2011 for the course FIN 448 taught by Professor Weiyang during the Spring '10 term at Rochester.

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

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