QUESTION 1:

1. The value of a companys equity is $10 million, and the volatility of its equity is 40%. The debt that will have to be repaid in three years is $25 million. The risk-free interest rate is 5% per annum. Assume that the probability of default was estimated using Mertons model to be 6.31%.

Part A: Calculate the following:

The market value of debt.

The present value of promised debt.

The expected loss on debt.

The recovery rate.

Part B:

5. The KMV EDF model is a modified version of Merton's model that is well-used in the industry. Explain the relative strengths of th