Which of the following statements about the Merton model for probability of default would decrease the probability of a firm defaulting on its debt? An increase in:
I. firm value. II. firm value volatility. III. the expected return on the firm.
A. II and III. B. III only. C. I and III. D. I, II, and III.
Statements I and III are true. Statement II is false because the firm value volatility is directly related to the probability of default; therefore, an increase in volatility will increase the probability of default.
