Your friend wants to borrow some money to start a business. While it's only $10,000, you still want to do some analysis to make sure it is a worthwhile investment. If you don't lend your friend the money you will buy a Canada Savings Bond with the funds instead which pay 5.5%, You know that your friend is thinking of buying a new car. If they do so, you figure it will reduce their probability to pay you back. In your analysis, you decide that the odds of your friend defaulting is 5% if they don't buy the car, and 10% if they do buy the car. If they default, that means that they won't pay back the principal or the interest outstanding. You take a look at your friend's car and realize a new one is needed so you put the probability of a new car purchase at 70%. If you are a risk neutral investor (ie you have a utility function equal to your net payoff), what is the minimum rate of return your friend will have to offer in order for you to loan them the money

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To calculate the minimum rate of return your friend will have to offer in order f... View the full answer