Suppose Melvins Bank can make a bet on derivatives that has a 2/3 probability of earning $20
Question:
a. Assume Melvin’s has $20 in capital. What are the possible costs and benefits of the bet for Melvin and the deposit insurance fund? Is Melvin likely to make the bet?
b. How are the answers in part (a) different if Melvin’s Bank has $50 in capital? What if it has $0 in capital?
c. In light of these examples, discuss the benefits of (i) capital requirements, (ii) bank supervision, and (iii) quick closure of insolvent banks.
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a If the bet is successful then Melvins net worth increases by 20 If the bet is lost then Melvins lo...View the full answer
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