Hello, I append the question below
The answer is B. Can someone explain this to me please? Is it because when we say “implied credit spread”, this is the credit spread implied by equity prices?
Thank you!
I don’t know if it’s what’s used here, but in Hull’s book on options, and elsewhere, there’s an approximation
Implied Credit Spread = (1 - Recovery Rate) \times Default Probability.
The question is telling you the bond is underpriced by the market so buy the bonds.
The other 2 choices involve selling the bonds.
If there is a default, the equity will be worthless and you don’t have to cover the equity short.
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