You are estimating the probability of default for a given firm using the options model of default risk where this probability is given by Prob Default = N(-DD), and DD is the distance-to-default, calculated using the formula we covered in class.

While implementing this model, you decided to consider the risk of default over a one-year horizon and set the face value of the debt in one year as the current book value of the debt. You also collected the following additional information on the firm:

• Current book value of debt = $190M
• Current market value of equity = $400M
• Equity volatility = 0.81 (measured during the past year)
• Value of D/A (measured during the past year) = 0.4

Moreover, you decided to use the simple approach described in class to compute the value of the firms assets and its asset volatility. Finally, you decided to set the value of equal to 5%. Following these steps, you first calculated DD and then determined the risk of default using the table below for the standard normal distribution.

Standard Normal Distribution (Mean = 0, Std Dev = 1).

P(Z z) z

3.0% -1.88

2.0% -2.05

1.0% -2.33

0.5% -2.58

0.2% -2.88

0.1% -3.09

In this context, what can you say about the probability of default?

Group of answer choices

The probability of default is between 1.0% and 2.0% (excluding these values).

The probability of default is between 2.0% and 3.0% (excluding these values).

The probability of default is between 0.2% and 0.5% (excluding these values).

The probability of default is between 0.1% and 0.2% (excluding these values).

The probability of default is between 0.5% and 1.0% (excluding these values).