Table 1 shows the results of using this type of distribution to value simple securities.

The simple transaction presumes three securities: senior debt, mezzanine debt and equity. There is $92 million of senior debt and $4 million of mezzanine debt. The remaining balance represents the equity.

Using the model assumptions of 10% defaults, 25% severity and a 30% correlation, I determined the coupon required for each bond. Each bond is then repriced under a variety of scenarios. There are many interesting observations that can be made from the table. In particular, note how changing the correlation does not affect the value of the asset, but it does affect the distribution of value between the bonds. Also, note how a higher probability of default has the same impact as a higher severity on the value of the asset. However, they have different effects on the value of the securities.

 

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