Suppose company Z is already in financial distress and the equity holders are very close to default. Suddenly there is a shock that causes an increase in the standard deviation of the return on company Z’s assets. Which of the following correctly describes the new situation faced by company Z?
A) Debt value will increase with the shock and equity holder are more likely to default.
B) Equity value will increase with the shock and equity holder are less likely to default.
C) Both Debt value and equity value will increase but the likelihood of default is unchanged.
D) Both debt value and equity value will decrease and the likehood of default will increase.
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