Assume that a country currently has a 20% probability of default. The risk-free rate is 4%.

a. Calculate this country’s lending rate.

b. Illustrate the country’s situation on repayment probability and loan market diagrams. Stack your diagrams vertically to ensure they are consistent.

c. Suppose that this country experiences a decrease in the volatility of output, resulting from improvements in the implementation of monetary policy. The probability of default decreases to 12% after this change. Calculate the new lending rate.

d. Using the diagrams from (b), illustrate how this change affects the repayment probability, lending rate, and amount borrowed.