1) What is capital rationing? Why may a bank impose capital rationing? (10 marks) 2) Suppose...

 

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1) What is capital rationing? Why may a bank impose capital rationing? (10 marks) 2) Suppose that one bank has 2000 loan applications with each application asking for a loan of $100 when the bank announces that the interest rate it charges is 29%. Half of the applicants are low-risk borrowers who invest the loan in project A. The other half of the applicants are high-risk borrowers who invest the loan in project B. The payoffs of these two projects one period from now are as follows: payoff probability 130 0.9 Project A 0 0.1 135 0.8 Project B 0 0.2 The bank has only $100,000 to lend. The riskless interest rate is 5% and the interest rate that equates the demand and supply of loans (market clearing interest rate) is 34%. Please numerically demonstrate that the bank's rational decision is to apply capital rationing (with a random approach) in this example. (10 marks) 1) What is capital rationing? Why may a bank impose capital rationing? (10 marks) 2) Suppose that one bank has 2000 loan applications with each application asking for a loan of $100 when the bank announces that the interest rate it charges is 29%. Half of the applicants are low-risk borrowers who invest the loan in project A. The other half of the applicants are high-risk borrowers who invest the loan in project B. The payoffs of these two projects one period from now are as follows: payoff probability 130 0.9 Project A 0 0.1 135 0.8 Project B 0 0.2 The bank has only $100,000 to lend. The riskless interest rate is 5% and the interest rate that equates the demand and supply of loans (market clearing interest rate) is 34%. Please numerically demonstrate that the bank's rational decision is to apply capital rationing (with a random approach) in this example. (10 marks)

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1Capital rationing is the process of allocating capital to investments in a way that maximizes the r... View the full answer