There are many banks in a country. Each bank holds a portfolio of corporate loans that...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
There are many banks in a country. Each bank holds a portfolio of corporate loans that will pay off $100M next year as well a portfolio of mortgage loans. Half of the banks have made good mortgage loans; these "good" banks will receive a payoff from their mortgage loans of $80M next year. The other half have made bad mortgage loans; these "bad" banks will receive a payoff from their mortgage loans of $20M next year. Neither the corporate loan nor mortgage loan portfolios generate any payoff after next year. Banks have no cash and no other assets. Each bank owes $90M of debt that it must pay off today by raising $90M of cash. It can do so in one of two ways. It can issue $90M of equity to new investors or it can sell off its corporate loan portfolio for $90M (a $10M discount to its true value of $100M). A bank cannot sell its mortgage portfolio. The bank owes no other debt. Existing shareholders receive a payoff of $0 if the bank defaults on its debt, so the bank will not default. A bank's manager knows whether her bank is a good bank or a bad bank, but outside investors only know that there is an equal probability that any bank is a good bank or a bad bank. Outside investors are also aware of each bank's need to pay off its loan. In making decisions, bank managers maximize value for their existing shareholders. Assume no discounting and no taxes. Assume that investors in the market believe that a good bank will liquidate its corporate loan portfolio while a bad bank will issue equity. This assumption is reasonable since a good bank will naturally worry about the dilutive effects of issuing equity, and the loss from liquidating the corporate loan portfolio is not too big. Demonstrate that, given this assumption by the market, a good bank will, in fact, liquidate its corporate loan portfolio and a bad bank will, in fact, issue equity. Support your answers with calculations. There are many banks in a country. Each bank holds a portfolio of corporate loans that will pay off $100M next year as well a portfolio of mortgage loans. Half of the banks have made good mortgage loans; these "good" banks will receive a payoff from their mortgage loans of $80M next year. The other half have made bad mortgage loans; these "bad" banks will receive a payoff from their mortgage loans of $20M next year. Neither the corporate loan nor mortgage loan portfolios generate any payoff after next year. Banks have no cash and no other assets. Each bank owes $90M of debt that it must pay off today by raising $90M of cash. It can do so in one of two ways. It can issue $90M of equity to new investors or it can sell off its corporate loan portfolio for $90M (a $10M discount to its true value of $100M). A bank cannot sell its mortgage portfolio. The bank owes no other debt. Existing shareholders receive a payoff of $0 if the bank defaults on its debt, so the bank will not default. A bank's manager knows whether her bank is a good bank or a bad bank, but outside investors only know that there is an equal probability that any bank is a good bank or a bad bank. Outside investors are also aware of each bank's need to pay off its loan. In making decisions, bank managers maximize value for their existing shareholders. Assume no discounting and no taxes. Assume that investors in the market believe that a good bank will liquidate its corporate loan portfolio while a bad bank will issue equity. This assumption is reasonable since a good bank will naturally worry about the dilutive effects of issuing equity, and the loss from liquidating the corporate loan portfolio is not too big. Demonstrate that, given this assumption by the market, a good bank will, in fact, liquidate its corporate loan portfolio and a bad bank will, in fact, issue equity. Support your answers with calculations.
Expert Answer:
Answer rating: 100% (QA)
I cannot provide verbatim text from the image but I can give you a detailed explanation based on the provided scenario in this image The scenario is about banks in a country that have to make a choice ... View the full answer
Related Book For
Financial Reporting and Analysis
ISBN: 978-1259722653
7th edition
Authors: Lawrence Revsine, Daniel Collins, Bruce Johnson, Fred Mittelstaedt, Leonard Soffer
Posted Date:
Students also viewed these finance questions
-
The Crazy Eddie fraud may appear smaller and gentler than the massive billion-dollar frauds exposed in recent times, such as Bernie Madoffs Ponzi scheme, frauds in the subprime mortgage market, the...
-
Emerson Electric Company was founded in 1890 as a manufacturer of motors and fans. In 1993, Emerson marked its thirty-sixth consecutive year of improved earnings per share. On $8.2 billion sales, the...
-
Analiza can paint a room in 3 hours. Leoben can do it for 2 hours. Walter can do the painting job in 5 hours. If all them worked together, how long will it take them to paint the room?
-
A rowboat heads directly across a river at a speed of 3 m/s. Convince your classmates that if the river flows at 4 m/s, the speed of the boat relative to the riverbank is 5 m/s.
-
Find the real solutions of each equation. V2t - 1 1 =
-
Trevor Ltd manufactures and sells four products A, B, C and D. The selling prices, variable costs, and number of machine hours required to produce each product are as follows. Each of the four...
-
Suppose you hold two series of options, both NQOs. Because of a big promotion, you expect your tax rate to increase from a current 31% to 39.6%. The current stock price is $70. The first set of...
-
On June 1 , Year 1 , Williams Inc. paid $ 4 , 8 0 0 for a two - year insurance policy with coverage beginning that day. How much insurance expense will Williams Inc. report in its Year 1 income...
-
The production manager at a factory manufacturing four types of light fittings (A, B, C and D) on an automated machine is fixing the schedule for the next week on this machine. HEIJUNKA SCHEDULING OF...
-
The graph of y = f(x) is shown below. If and A are positive numbers that represent the areas of the shaded regions, then find, in terms of 4 and 42, the following: (a) f f(x) dx (31) jf(x) dx (v)...
-
(a) If $20,000 is now borrowed from a bank and repay by monthly payment for two years. The bank charges a flat rate of 0.5% per month. Calculate the amount of interest for this loan. [4 marks] (b)...
-
Aside from the 50,000 monthly rental for leased premises, X paid ABC Corporation (lessor) 5,000 representing the agreed share of X in the payment of the real property tax on the leased property. How...
-
1: Factor the following polynomial: 3r+3x-243x-243= ?
-
Pound Industries is attempting to select the best of three mutually exclusive projects. The initial investment and after-tax cash inflows associated with these projects are shown in the following...
-
4. Given two lists A of size m and B of length n, our goal is to construct a list of all elements in list A that are also in list B. Consider the following two algorithms to solve this problem....
-
The Bears Corporation practices a strict residual dividend policy and maintains a capital structure of 60%debt, 40%equity. Earnings for the year are $5,000. a. What is maximum amount of capital...
-
Write a while loop that uses an explicit iterator to accomplish the same thing as Exercise 7.3. Exercise 7.3. Write a for-each loop that calls the addInterest method on each BankAccount object in a...
-
Regulated utilities such as Duke Power Co. (a subsidiary of Duke Energy Corporation) are authorized to earn a specific rate of return on their capital investments. Energy regulators set a rate the...
-
Ashley Stores, Inc., sells gift cards for use at its stores. The following data pertains to 2019, 2020, and 2021, the company's first three years of operation: As of December 31, 2019, Ashley...
-
McDonalds, the global fast-food restaurant giant, was sued in 2009 by a former employee who said she was dismissed because, as a senior director of executive compensation, she objected to a complex...
-
Often a linearly sloped beach is not a good model. Waves coming from deep water up a gradually shelving beach are better approximated by assuming a parabolic shape like that shown in Figure P7.6...
-
In the design of a horn tweeter, which parameter is most critical in specifying where the cutoff frequency for the loudspeaker would lie? Why?
-
Is wavelike motion an example of conservative or diffusive motion?
Study smarter with the SolutionInn App