The volatility of a firms assets is 20%. The firms assets are worth $200 million and are
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The volatility of a firm’s assets is 20%. The firm’s assets are worth $200 million and are normally distributed. The risk-free rate of interest is 2% and the expected rate of return on the firm is 10%. The firm has $100 million in face value of debt maturing in one year. Compute both the risk-neutral and the real-world one-year default probabilities for this firm. Which is higher? Why?
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