Question 1. A firm is issuing a two-year debt in the amount of $200 000. The current market value of the assets is $300 000. The risk-free rate is 6 per cent, and the standard deviation of the rate of change in the underlying assets of the borrower is 10 per cent. Using Merton’s model, determine the following:

a) The current market value of the loan, and

b) The risk premium to be charged on the loan.

Question 2: Suppose that each of two investments has a 4% chance of loss of $ 10 million, a 2% chance that of loss of $1 million, and a 94% chance of profit of $1 million. They are independent of each other.

a) What is the VaR for one of the investments when the confidence level is 95%?

b) What is the expected shortfall when the confidence level is 95%?

c) What is the VaR for a portfolio consisting of the two investments when the confidence level is 95%?

d) What is the expected shortfall of for a portfolio consisting of the two investments when the confidence level is 95%?