Credit spreads in the Merton (1974)model will be increasing,ceteris paribus,when
A)Stock volatility decreases.
B)The growth rate of the firm decreases.
C)Leverage increases.
D)The risk-free rates increase.

Question

Quizplus · Accepted Answer

if volatility decreases,risk falls,and spreads fall.The growth rate of the firm does not matter,as the spreads are determined in a risk-neutral setting and the growth rate does not enter the formula for spreads.When risk-free rates increase,the put option that proxies for the spread declines in value and spreads will in fact decrease.But spreads do increase when leverage increases.

Credit Spreads in the Merton (1974)model Will Be Increasing,ceteris Paribus,when