Question: Consider two fir arms which differ from each other in terms of valle and risk of corporate assets, and degree of financial leverage. Firm 1

Consider two fir arms which differ from each
Consider two fir arms which differ from each other in terms of valle and risk of corporate assets, and degree of financial leverage. Firm 1 owns assets worth $30,000,000, and has issued zero coupon bonds with a face value of $15,000,000. On the other hand, Firm 2 owns assets worth $50,000,000, and has issued zero coupon bonds with a face value of $30,000,000. The standard deviation for Firm I's assets is o = 30%, whereas the standard deviation for Firm 2's assets is o = 40%. Assume that both firms will be liquidated one year from today and that the rate of interest is 3%. 1. What is the fair market value for the bonds issued by Firm 1? What is the dollar value of Firm I's limited liability put option? What is the yield to maturity, credit risk premium, and the risk neutral probability of default for Firm I's bonds? 2. What is the fair market value for the bonds issued by Firm 2? What is the dollar value of Firm 2's limited liability put option? What is the yield to maturity, credit risk premium, and the risk neutral probability of default for Firm 2's bonds? 3. Suppose an insurer offers credit enhancement schemes to both firms which ensure that neither firm will default on its debt. Assuming that the credit enhancement market is competitively structured, how much should each firm expect to pay for this service, and what impact will credit enhancement have on the yields to maturity for these bonds

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