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The first step in any family succession plan is to choose the appropriate heir for the business. Where there is only one heir, it is necessary to decide whether he or she wishes to, and is capable of, taking over the business. If there is more than one suitable candidate, it is necessary to decide which one will be chosen. The factors to consider include business aptitude and management potential. Potential is more important than experience, because you can groom your heir for the role as owner/manager over an extended period.

In theory, the steps involved and the logic employed in choosing the appropriate heir should be similar to those involved in choosing the best CEO for the business, or the lead manager in a management buy-out: that is, the heir you choose should be the one most capable of running the business successfully when you leave. In practice, however, the choice may be made for various personal and family related reasons, rather than on solid business-based grounds.

Where there is only one heir (or only one heir who is interested in taking over the business), obviously it might still be a mistake, on purely business grounds, to hand over the business to that heir. But, if this is to be the case, your task is to make the best of a dubious decision and to prepare this person as best you can for the role of running the business.

As we have pointed out for short-term spreads expected recovery value may be too high for short-term liabilities due to the assumptions of the model. Commercial implementations of the original structural model are more sophisticated, in order to produce more accurate spreads, default probabilities and recovery rates even for short time horizons. While in pure diffusion models with a barrier overnight debt is quasi-riskless, the introduction of a jump process captures the fact that default could be triggered by a sudden, unexpected event. Thus, the jump process is appropriate to model the possibility of the firm defaulting instantaneously due to the arrival of negative information with respect to, for example, litigation or fraud.

In the structural approach, assets and liabilities of a company are modeled simultaneously. Thus, structural models are based on fundamental company data, focusing on its balance sheet and asset value. Default occurs when the value of the firm’s assets falls below its liabilities. Consequently, the required inputs comprise the firm’s liabilities, usually taken from its balance sheet, market value of equity and (implied) equity volatility. Since equities are typically more liquid than corporate bonds, one may argue that equity prices tend to reflect the value of a company’s assets more accurately.

Using information from the equity markets allows fixed income instruments to be priced independently, without requiring credit spread information from related fixed income instruments. However, if equity prices become irrationally inflated or deflated, as we have experienced during the equity hype of the late 1990s, they may be misleading indicators of actual asset values. Generally it is assumed that one can reasonably infer asset values from equity prices. An option pricing model is then used to derive the volatility of the firm’s assets. Although it is generally possible to model financial institutions in the structural framework they should be treated with caution, since it is difficult to assess their assets and liabilities.

Furthermore, since financial institutions are highly regulated, default may not occur even if the value of assets falls below the firm’s liabilities.

The securities issued by the U.S. Department of the Treasury are backed by the full faith and credit of the U.S. government. Consequently, market participants through¬out the world view,them as having no credit risk. As such, interest rates on Treasury securities are the key interest rates in the U.S. economy as well as in international capital markets. The large size of any single issue has contributed to making the Trea¬sury market the most active and hence the most liquid market in the world.

The minimum interest rate that investors want is referred to as the base interest rate or benchmark interest rate that investors will demand for investing in a non-Trea¬sury security. This rate is the yield to maturity (hereafter referred to as simply yield) offered on a comparable maturity Treasury security that was most recently issued (“on the run”). So, for example, if an investor wanted to purchase a 10-year bond on September 19, 1997, the minimum yield the investor would seek is 6.086%, the yield on the most recently issued 10-year Treasury