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Explain the effect on participant

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Consider a firm managed by an entrepreneur. The firm has two kinds of debt outstanding: senior debt under which it owes $1,250 to bondholders, and a subordinated bank loan that requires a repayment of $2,550. The firm's assets have a current liquidation value of $2,800 but if the firm continues to operate, it will be worth $3,750 with probability 0.8 and $100 with probability 0.2 one period hence.

To manage the firm for an additional period, the entrepreneur incurs a personal cost of $400. The entrepreneur has declared that she wishes to file for bankruptcy and has contacted both the bank and the bondholder's trustee. The bondholders wish to liquidate the firm immediately. Assume risk aversion by the participants and explain the effect on each participant. How would you recommend solving this problem? What should the bank do?

Reference no: EM133111171

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