A firm has total assets with a market value of $1,500,000. It has one issue of 1,000 zero coupon bonds outstanding, each with a face value of $1,000 and a maturity of 3 years. The volatility of the assets is 20%, and the risk-free rate is 5%.
a. What is the market value of the firm's equity?
b. What is the market value of the bonds?
c. What is the continuously compounded yield on the bonds?
d. Analyze the credit risk structure for this firm by varying the maturity on the bonds from 3 to 7 years. Discuss this credit risk structure.