Reference no: EM132459113

A low value of a leveraged asset (that is, a property which carries a mortgage) could cause the equity owner to minimize his loss by opting to default on his monthly coupon payments, eventually causing the lender(s) to foreclose on his property. One might be hesitant to believe our analysis because we did not explicitly include all of the costs to the equity owner of default, which - in addition to the loss of title to his property - would include a variety of penalties suck as either a limited ability to borrow for some number of years after default or obtaining a loan in that period only if he agrees to an exorbitant coupon rate. If we assume these additional costs to default add up to a value (discounted to the time of default) M, depict graphically the new payoff to the equity holder in the case of his property assuming two random values, as before, in the amounts V₁1 and V₁2 where V₁1 as usual illustrates a property value less than the value of the outstanding debt. Will the equity owner default at any value of V₁ below the value of his mortgage debt? If not, at what of V₁ would he default? What does this do the payoff to the lender?