THE JOURNAL OF FINANCE
VOL. LI, NO. 3
JULY 1996
Optimal Capital Structure, Endogenous
Bankruptcy, and the Term Structure of
Credit Spreads
HAYNE E. LELAND and KLAUS BJERRE TOFT*
ABSTRACT
T his article examines the optimal capital structure of a f irm that

American Finance Association
Corporate Debt Value, Bond Covenants, and Optimal Capital Structure
Author(s): Hayne E. Leland
Source: The Journal of Finance, Vol. 49, No. 4 (Sep., 1994), pp. 1213-1252
Published by: Wiley for the American Finance Association

BEM 109
Homework 4
Due: 6/7, Friday, 12pm
Note: This homework is optional for seniors. You may submit the homework
either in Thursday during (the last) lecture, or email the le to me. Please do NOT
put it in my mailbox, since I will start summer travel an

BEM 109
Homework 3
Solutions
1. (i) Let N be a Poisson process with constant parameter . That is, N0 = 0, N
has independent increments, and lP(Ns Nt = k ) =
(st)k (st)
e
.
k!
Denote 0 := 0,
n := inf cfw_t : Nt n, and En := (n n1 ), n 1. Show that E1 , E2

BEM 109
Homework 2 Solutions
1. Consider the following extension of the Mertons model. The rms asset value
V is as in Mertons model:
rt = r,
dVt = Vt rdt + dWt .
(0.1)
However, the debt is split into senior and junior debt with face values DS and DJ ,
res

BEM 109
Homework 1 Solution
1. Consider the following Ho-Lee model:
drt = tdt + dWt .
(0.1)
where W is a Brownian Motion under the risk neutral measure lP .
T
(i) Use the formula p(t, T ) = I lP e t rs ds to nd p(t, T ).
Et
(ii) Apply Ito formula to check