Question: Consider two firms which differ with respect to asset risk and financial leverage. Firm 1 owns assets worth $10,000,000, and has issued zero coupon bonds

Consider two firms which differ with respect to asset risk and financial leverage. Firm 1 owns assets worth $10,000,000, and has issued zero coupon bonds with a face value of $4,500,000. On the other hand, Firm 2 owns assets worth $25,000,000, and has issued zero coupon bonds with a face value of $15,000,000. The standard deviation of the return on firm 1s assets is 40%, whereas the standard deviation of the return on firm 2s assets is 50%. 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 1s limited liability put option? What is the yield to maturity, credit risk premium, and (risk neutral) probability of default for Firm 1s bonds?

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