Question
A firm has assets of 120m. The volatility of the assets is 40%. The riskless rate is 10% continuously compounded. (a) Set up a 3
A firm has assets of 120m. The volatility of the assets is 40%. The riskless rate is 10% continuously compounded. (a) Set up a 3 period binomial lattice for the assets of the firm for three years. (b) Compute the risk neutral probability. (c) Assume a three year zero coupon bond exists with face value 70m. Compute the value of the equity and the zero coupon bond at each node of the lattice. (d) What is the current value of the bond, and what is the continuously compounded credit spread. (e) Assume a two year European call option existed on the bond with strike price 50. Compute its price. (f) Now value a callable zero coupon bond. The bond has three years to maturity, a Face value of 70m and is callable in year two with a strike price of 50 (f) Assume a two year European call option exists on the equity with strike 100. What is its price today.
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