The world is risk neutral and interest rates are 20%. With probability ¼, your firm will...

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The world is risk neutral and interest rates are 20%. With probability ¼, your firm will...

The world is risk neutral and interest rates are 20%. With probability ¼, your firm will be worth $60 next year. With probability ¾, it will be worth $100. What interest rate do you have to promise to raise $70 in debt today?

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Answer 1

Answer #1

Let the rate to be promised be r

70*(1+20%)=1/4*60+3/4*(70*(1+r))
=>r=92/70-1
=>r=31.429%

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Answer 2

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