ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions
Zeta Co has assets worth $100m and a single zero-coupon debt issue with a face value of $80m due in one year. Using option pricing, equity is valued at $28m. What is the promised (yield to maturity) return on the debt?
The promised yield is 11.1%. Debt is worth the asset value of $100m less equity of $28m, which is $72m. The lenders are promised $80m in one year, and 80 divided by 72 minus one gives 11.1%.
- A11.1%Correct
- B28.0%
- C38.9%
- D10.0%
Explanation
Debt value = asset value − equity = 100 − 28 = $72m. Promised yield = 80/72 − 1 = 11.1%. Using 100/72 − 1 = 38.9% wrongly takes asset value as the payoff, and 10% is the face-value discount on 80 (8/80).
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