Use the Black€“Scholes model and redraw Figures (a) and (b) assuming that the standard deviation of the return on the firm€™s assets is 40% a year. Do the calculations for 60% leverage only. What does this tell you about the effect of changing risk on the spread between high-grade and low-grade corporatebonds?

Transcribed Image Text:

DFIGURE (a) 3.0 2.5 2.0 1.5 1.0 0.5 0.0 : DIV-2 B: DV.6 Bo: D/V-.4 1 3 5 7 9 13 15 17 9 21 23 25 Maturity of debt, years FIGURE (b) 1.8 Leverage2 Leverage- 4 Leverage -6 1.2 0.8 0.6 0.4 0.2 0.0 1 3 5 79 11 13 15 17 19 21 23 25 Maturity of debt, years