Analyst Greg is employing the Merton model to both value a firm's equity and estimate a physical default probability. He has collected the following information:

• The firm's default threshold one year forward is $10 million; e.g., face value of short-term debt is $10 million.

• The firm current asset value is $12.75 million with an expected return of 8% per annum with continuous compounding

• The volatility of the firm's assets is 9.6%

• The risk-free rate is 2%

His exercise includes two components: one, valuation of the firm's equity market value by treating equity as a call option on the firm's assets; two, estimate of default probability by calculation of a forward distance to default. Greg makes two assumptions:

I. An increase in the risk-free rate will increase an estimate of the firm's current equity market value, and

II. An increase in the risk-free rate will decrease the estimated default probability.

Which of Greg's two assumptions is correct?