Assume a 1-year Treasury security offers a risk-free rate of return of 6%. The B. Smith
Company wants to borrow $100,000 from its bank. The banker believes that B. Smith
has a 30% chance of defaulting on the loan, in which case the company will be able to
repay only $40,000. What must B. Smith promise to repay in order for the bank to buy
the loan? What is the default premium and the time premium, assuming a risk-neutral
world?

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The Answer of Assume a 1-year Treasury security offers a risk-free rate of return of 6%. The B. Smith
Company wants to borrow $100,000 from its bank. The banker believes that B. Smith
has a 30% chance of defaulting on the loan, in which case the company will be able to
repay only $40,000. What must B. Smith promise to repay in order for the bank to buy
the loan? What is the default premium and the time premium, assuming a risk-neutral
world?

Assume a 1-Year Treasury Security Offers a Risk-Free Rate of Return