Consider a portfolio which consists of two defaultable bonds. The asset values of these companies are...

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Consider a portfolio which consists of two defaultable bonds. The asset values of these companies are described by the Black-Scholes model. The first bond with face value of 100 matures in 10 years, and is issued by Firm 1 whose assets are worth 150 and have an (annual) volatility of 10%. The second bond with face value of 200 matures in 20 years, and is issued by Firm 2 whose assets are worth 250 and have an (annual) volatility of 20%. The correlation between the two firms' assets is 0, and the risk-free rate is 5%. Neither firm pays any dividends. For the purpose of computing the daily VaR below, assume that the mean returns for both firm's assets are zero. Use three decimal places for your answers. (a) [1 point] What is the value of Firm I's equity? (b) [3 points] What is the spread on Firm 2's defaultable bond in %? (c) [1 point] What is the daily 5% VaR for Firm I's defaultable bond? (d) [3 points] What is the daily 5% VaR for the bond portfolio? Consider a portfolio which consists of two defaultable bonds. The asset values of these companies are described by the Black-Scholes model. The first bond with face value of 100 matures in 10 years, and is issued by Firm 1 whose assets are worth 150 and have an (annual) volatility of 10%. The second bond with face value of 200 matures in 20 years, and is issued by Firm 2 whose assets are worth 250 and have an (annual) volatility of 20%. The correlation between the two firms' assets is 0, and the risk-free rate is 5%. Neither firm pays any dividends. For the purpose of computing the daily VaR below, assume that the mean returns for both firm's assets are zero. Use three decimal places for your answers. (a) [1 point] What is the value of Firm I's equity? (b) [3 points] What is the spread on Firm 2's defaultable bond in %? (c) [1 point] What is the daily 5% VaR for Firm I's defaultable bond? (d) [3 points] What is the daily 5% VaR for the bond portfolio?

Answer rating: 100% (QA)

SOLUTION a The value of Firm Is equity can be calculated using the BlackScholes formula d1 lnVFirm1B... View the full answer