Suppose The Midtown Community Bank is faced with two types of borrowers that it cannot distinguish, G

Question:

Suppose The Midtown Community Bank is faced with two types of borrowers that it cannot distinguish, G and B. The type-G borrower wishes to borrow $100 to invest in a single-period project that yields $135 with probability 0.9 and zero with probability 0.1 at the end of the period. The type-B borrower wishes to borrow the same amount in a project that yields $150 with probability 0.4 and zero with probability 0.6 at the end of the period. 25 If the borrower comes to the bank for a loan in the second period, it will be to finance exactly the same kind of project as in the first period. Assume that The Midtown Community Bank is perfectly competitive and there is universal risk neutrality. Compute the borrower’s interest rates on its first- and second-period loans. Midtown’s cost of funds is 5%, the riskless rate. Assume that the bank’s prior belief is that there is a 0.8 probability that the borrower is of type G and a 0.2 probability that it is of type B.

Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question

Contemporary Financial Intermediation

ISBN: 9780124052086

4th Edition

Authors: Stuart I. Greenbaum, Anjan V. Thakor, Arnoud Boot

Question Posted: