Consider a firm with current value of $5,000,000 and outstanding debt of $4,000,000 that matures in 10 years. The firms asset rate-of-return variance is .5.
The interest on the debt is paid at maturity, and the firm has a policy of not paying cash dividends. Use the OPM to determine the change in the prices of the firms debt and equity if there is an unanticipated rise in the rate of inflation of 5%, which raises the riskless nominal interest rate from 5% to 10%. Which class of security holders benefits from the rise in rf?