MBA Inc.

Market Value of Assets $ 10 million

Face value of pure discount bond $ 4 million

Debt Maturity 3 years

Asset return ? 60%

R_f 5%

Compute market value of debt and equity. Use Table 17.3. DO NOT INTERPOLATE!!!

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The estimated price of $5.85 is greater that the $4 price actual price, implying that the call option is underpriced. A trader believing in the Block-Scholes model would buy a call, of course, the Black-Scholes model is fallible. Perhaps the disparity between the model's estimate and the market price reflect error in the trader's estimate of variance