medium · Corporate Credit Analysis cca-core
Underworld Inc. has a Probability of Default (PD) of 1% over the next year.
According to the Merton framework, what is the most likely outcome for a creditor holding a 1,000 bond at par?
- The bond's market value rises 1% once the default probability is realized.
- The creditor receives exactly what was lent plus interest (the asymmetric payoff).
- The creditor is guaranteed to lose exactly 1% of the bond's total outstanding par value.
- The creditor captures unlimited equity-like upside if Underworld's stock price ever doubles.
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