Structural Models and Default Risk Analysis

Medium Credit Analysis And Valuation Structural Models

The credit analysis is an essential component in assessing the risk associated with fixed income securities. Structural models of credit risk utilize the concept of a firm's assets and liabilities to estimate the probability of default.

Consider a company that has total assets valued at $500 million, total liabilities of $400 million, and its asset volatility is measured at 30%. Using a structural model, if the firm’s equity value is determined to fall below the value of its liabilities, it is indicated that the firm has defaulted.

Based on this information, which of the following statements regarding the potential default of the firm is most accurate?

The firm has a strong likelihood of default if the market value of its assets drops below $400 million.

The firm's default risk is primarily influenced by the volatility of its liabilities.

The asset value must remain above $500 million to avoid default.

Hint

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