Malz , Credit and Counterparty risk
4 important questions on Malz , Credit and Counterparty risk
Name two characteristics of prefered stock that are similar to bonds, and two that are similar to stock
Bonds:
- fixed dividends
- no voting rights
Stock:
- no fixed maturity
- no obligation to pay dividend
What means 'recourse' in secured lending?
The lender's right for clainms agains the borrower's assets beyond the value of the collateral
Explain double default risk
Risk that the counterparty that sold default protection on a third party will default at the same time as the third party (e.g. AIG)
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What are the seven assumptions of the Merton model?
- Market value of assets and expected return are related. Markets are in quilibrium and investors expect to earn a constant risk premium.
- The firm can only default at maturity of the bond.
- Equity consists of common shares only
- Debtholders have limited liability and no recourse to any other assets once equity is eliminated.
- No negotiation between debt and equity holders; first full repayment of debt holders.
- Trading in the market occurs for equity, debt and assets.
- There are no cash flows prior to the maturity of debt.
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