Your company has issued zero-coupon bonds with face value of 600 million (represented by

600'000 zero-coupon bonds) 3 years ago; the maturity of this issuance is now exactly 2 years. The

value of the assets of the company is estimated to be 500 million today with an annual volatility

of its relative variations of 50%. The subjective probability of an up movement is equal to

46.39% and the equity is represented by 300000 shares. The risk-free rate in the market today is,

estimated at 2%, and the market risk premium is 5% (we accept the working hypothesis of

Mertons debt and use these in a binomial setting; all rates are annual in the present problem). To

answer the following questions use a binomial tree with steps of 1 year.

Requirements

A) Use a two-period binomial tree to compute the value of the assets of the company.

B) Find the value of this debt today.

C) Decompose the value of debt in face value, risk free rate, loss-given-default and risk-neutral

default probability.

D) Find the asset's beta, the beta of debt (if you don't manage to get an answer for the assets

beta, use an assets beta of 1.4) and the cost of debt.

E) Compute the yield of debt and compare it to the cost of debt found in the previous question.

Explain the difference between those numbers.