CHAPTER 20

19imaginetwostockseachwithamarketpriceof100foreachstoc

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Unformatted text preview: b. Value of default put = $350 ­ $280 = $70 16. Straddle Butterfly The buyer of the straddle profits if the stock price moves substantially in either direction; hence, the straddle is a bet on high variability. The buyer of the butterfly profits if the stock price doesn’t move very much, and hence, this is a bet on low variability. 17. a. The bond value increases to the present value of the guaranteed payoff, valued at the risk­free rate: Bond value = ($50 + $5)/1.08 = $50.93 b. The payoffs to stockholders are unaffected. If the firm defaults, its bondholders are paid off, but shareholders get nothing, just as before. If the firm does not default, payments to shareholders do not change. c. The firm effectively acquires a new asset, the government guarantee worth $25.93 (the difference between the previous and new bond values). The firm’s balance sheet could be expressed this way: Asset value Government’s guarantee $30.00 25.93 $55.93 $50.93 5.00 $55.93 B onds Stock Firm value d. By...
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