Increased volatility in the market value (price) of property clearly imposes risk on both the equity holder and the debtholder(s) by directly affecting the values of their respective claims on that value. Let's define, in this problem, "increased volatility" to be a "mean-preserving spread," in the case of a property that has current value V0 and has a random future (date 1) value of V1, which will be realized as one of two alternative low and high values, respectively denoted by V11 and V12. Such volatility is the precise definition of what both finance practitioners and researchers call 'financial risk." Further assume the mortgage used to finance the purchase of the property matures at this future date with a balance of F required to be paid at that date, where

 

V11 < F < V12.

 

If no costs other than the loss of his property are imposed on the equity holder if and when he causes a foreclosure by defaulting on the servicing of his mortgage, then

 

a. Do both equity holders and debt holders share a common preference for either or less volatility? If so, do they prefer more or less volatility? (Answer Yes or No)

 

b. If they have different preferences toward volatility, which one would prefer more volatility and which less?

 

c. In one sentence, explain why they have common attitudes toward volatility if you answered yes in (a) above or if you answered no in (a), then state which party prefers more and which less volatility.