Solve Exercise 7

Because D is the pre-outcome value of the debt and P is the promised pay-off, the ratio P/D is the (gross) promised yield or (gross) rate-of-return on the debt. As we next show, this yield is in general increasing in P, our measure of the amount of the debt. We draw this conclusion by studying the ratio D/P. If b > 0, then min{a,b} = min{0, 1}. Therefore, from (3), if P >0, then P= ps min{, 1}. (5) DS s=1 Exercise 7 According to (5), higher debt, as measured by P, either does not affect the promised yield or increases the promised yield. Describe the circumstances in which each conclusion holds. Because D is the pre-outcome value of the debt and P is the promised pay-off, the ratio P/D is the (gross) promised yield or (gross) rate-of-return on the debt. As we next show, this yield is in general increasing in P, our measure of the amount of the debt. We draw this conclusion by studying the ratio D/P. If b > 0, then min{a,b} = min{0, 1}. Therefore, from (3), if P >0, then P= ps min{, 1}. (5) DS s=1 Exercise 7 According to (5), higher debt, as measured by P, either does not affect the promised yield or increases the promised yield. Describe the circumstances in which each conclusion holds