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in black scholes formula to value the company r is taken as 5% (risk free rate), should not it more appropriate to take 8% ( yield rate of company debt)?
also, exercise price(Pe) is supposed to be equivalent zero coupon bond but here it is calculated as pv of the repayment value, if we want to find eqivalent zero coupon bond then should not the repayment value get higher?
please,correct me if my comments are wrong in any assumption.The problem is that in real life, debt is not completely risk free – there is always the risk of bankruptcy – so using 5% is correct.
I am a bit puzzled by what you say about the equivalent zero coupon bond. The wording is the question is a bit confusing, but the answer does what it asks – uses the same yield and the same term to maturity.
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thank you for your replies.
i just wanted to ask you, how do you use the formula to calculate the value at risk? The standard score should be taken from the normal distribution tables but i cannot figure it out. for example, the z value for a one-tailed 5% probability level is calculated as 1.645. I just don’t know where to get this info from. i would really appreciate your help.
btw, have you done this exam already?
thank s again 🙂This forum is to ask questions of the P4 tutor (which is me!) – (there is another P4 forum to ask questions of other students.)
I have certainly passed the exam (quite a long time ago 🙂 )The way you get 1.645 is from the normal distribution tables that are given in the exam.
What you do is this:
You take 5% from 50% which gives 45% (or 0.45). (The reason you take it away from 50%, if you are interested, is that because the normal curve is symmetrical, 50% lies below the average and 50% are above the average. For 5% at one end (one-tailed) it means that 45% lie between the 5% value and the average).
Anyway….having for 0.45, you use the tables ‘backwards’ in that you see how many standard deviations give an answer of 0.45.
If you look at the tables, you will see that 1.64 gives an answer of 0.4495 and that 1.65 gives an answer of 0.4505.
We want an answer of 0.45 and so it is somewhere between the two – approximately 1.645. (In fact it is only approximate because it is not linear)If you wanted it for 1% you follow the same rules: subtract from 50%, which gives 49% or 0.49. Then look for an answer in the tables of 0.49. You will find that 2.33 gives 0.4901 which is close enough 🙂
(You can do it the same way for any percentage, but 1% or 5% are the only ones we ever would normally look at)
Hope that helps 🙂
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Dear Mr. Moffat
Thank you so very much for your help. The explanation you gave me is so clear and simple, just great!
With Kindest regards
Gianina.
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