Use the Black–Scholes model and redraw Figures 23.5 and 23.6 assuming that the standard deviation of the return on the firm’s assets is 40% a year. Do the calculations for 60%

leverage only. ( Hint: It is simplest to assume that the risk-free interest rate is zero.) What does this tell you about the effect of changing risk on the spread between high-grade and low-grade corporate bonds? (You may find it helpful to use the Black–Scholes program on the “live” spreadsheet for Chapter 21 at www.mhhe.com/bma .)

AppendixLO1