Risky debt, bad bank and government

Risto Murto and Timo Eirola

No 16/1993, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: The purpose of this paper is to put forward a valuation framework for interest rate sensitive claims. We concentrate on secured loans. The value of the secured loan depends upon the coupon rate, the maturity, the term structure of interest rates and the value of the collateral as well as the probability of default. We follow Schwartz and Torous (1992) and assume that borrower's conditional probability of default is given by a hazards function. Furthermore, we value guarantees, junior secured debt and unemployment insurance.

Date: 1993
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