Which values of µ will there be transaction in cases

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Reference no: EM131336105

A CFO wants to sell a security. The CFO knows the true value. She is willing to sell the security at a maximum discount of 15%. A potential investor does not know the true value but does know that the true value equals 100 with probability μ, equals 62 with probability λ or equals 38 with probability 1-μ-λ. The investor is willing to pay at most the expected value of the security. (Note that 0≤μ, λ≤1.)

[a] For which values of μ and λ will there be a transaction in all cases (so if the security is worth 38, 62 and 100)?

Suppose the market price of the security equals 60.

[b] Given this information, what is the probability that the security has the lowest value (of 38)?

The book states that asymmetric information is a larger problem if the issued security is equity rather than debt.

[c] What is the reason?

Reference no: EM131336105

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