Lambda sells electric lawnmowers to the consumer market. Lambda’s only debt is a zero-coupon bond with a face value of 100 dollars that matures 9 months from today. Larry, the CEO of Lambda, is concerned that his company may need to default on these bonds. He estimates that Lambda’s market value of assets could be worth either 130 dollars or 90 dollars in 9 months. He estimates that the risk-neutral probability that Lambda’s assets are only worth 90 dollars is 20.0 percent. The risk-free interest rate is currently 5.0 percent per annum. 1. What is Lambda’s option to default worth in 9 months if the market value of assets is 90 dollars? 2. What is the risk-neutral value of Lambda’s option to default worth today? 3. What is the risk-neutral market value of Lambda’s debt today including the probability of default? 4. What is the market value of Lambda’s equity in 9 months if the market value of assets is 130 dollars? 5. What is the risk-neutral value of the shareholder’s option to buy Lambda’s assets off the debtholders in 9 months worth today? 6. What is the current market value of assets of Lambda?
Added by Karen N.
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If the market value of Lambda's assets is 90 dollars in 9 months, the company will default on its bond. The bondholders will receive the entire value of the company's assets, which is 90 dollars. The option to default is worth the face value of the bond minus the Show more…
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