Suppose there were two factors influencing the past default behavior of borrowers: the leverage or debt–assets ratio (D/A) and the profit margin ratio (PM). Based on past default (repayment) experience, the linear probability model is estimated as:
PDi = 0.105(D/Ai ) - 0.35(PMi )
Prospective borrower A has a D/A = 0.65 and a PM = 5%, and prospective borrower B has a D/A = 0.45 and PM = 1%. Calculate the prospective borrowers’ expected probabilities of default (PDi). Which borrower is the better loan candidate? Explain your answer.