Explanation:
The correct answer is D.
One of the major downsides of the Merton model is that it does not accurately predict default events in practice. The model relies on several simplifying assumptions, such as a simplified capital structure (typically assuming a single zero-coupon bond) and continuous lognormal asset value distributions. These assumptions ignore complexities like sudden jumps in asset value, multi-layered debt structures, and early default conditions, often leading to an underestimation of actual default probabilities compared to empirical data.
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Q.1803 One of the downsides of using the Merton model to determine the value of debt/equity is the fact that:
A
calculations are too complex.
B
the process requires considerable time and expertise.
C
it does not take into account any outstanding derivative contracts, such as call options.
D
it does not accurately predict default events.