Suppose that the current value of a company's operating assets is $100 million. company has 10-year zero-coupon debt outstanding the only debt it has with a principal amount at maturity of $155 million. Its debt has a yield to maturity of 10%. 

(a) Draw a payoff diagram of the company's debt at maturity, as a function of the value of its assets then. Be sure to label all relevant payoffs and axes. 

(b) Suppose that the government announces that the company is "too big to fail”, so it will fully and unconditionally guarantee the debt of the subsidiary, meaning that the government will ensure that its bonds always pay off the full amount that they owe. Draw the payoff diagram of the company's debt with the guarantee included. 

(c) What is the value of the guarantee? You can assume a risk-free rate of 5%.

Answer rating: 100% (QA)

Current value of companys operating asset is 100 million The company has 10 year old zero ... View the full answer