Question

Based on your understanding of structural models of default, equity holders are better off when, holding all else constant

1-The volatility of the firm’s assets increases.

2-The value of the firm’s assets decreases.

3-The debt maturity is shorter.

4-All of the above.

Answer 1

Volatility of an asset is an indication of sensitiveness of assets in accordance with different structural changes in the market.

equity shareholder is better off when the volatility is constant or low, because he does not want any kind of uncertainty in the market. Equity shareholders always like stability and certainity so that help them in multiplying their returns.

Increasing uncertainty is always a matter of concern for equity shareholders and when the uncertainty increases the volatility increases simultaneously leading to decrease in the value of equity share.

Show the correct answer would be (2) value of the forms asset decreases.