A firm is borrowing a two-year zero-coupon business loan from your bank with a repayment obligation of $7.582 million. You estimate that the market value of the firm’s total assets is $9.256 million. Risk-free interest rate is 3%, and the standard deviation of the rate of change in the underlying assets of the borrowing firm is 26%. Using the options framework, determine the following:

a) The current market value of the loan.

b) The interest rate to be charged on the loan.

Answer rating: 100% (QA)

We will first calculate the market value of equity as a call option on the a... View the full answer