A bank has a loan that matures in 1 year and is risky. With probability p...
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A bank has a loan that matures in 1 year and is risky. With probability p the loan defaults and the recovery value is 0.4. With probability 1-p the loan pays a gross return of 1.2. The expected future value of the loan (in one year) is thus 1.2*(1-p) + p*0.4 The bank discounts the loan at 10%. The value of the loan to the bank is thus (1.2*(1-p) + p*0.4)/1.1 The bank can sell the loan to competitive outside investors who discount at 7%. 3. MPC Suppose that everyone knows that p=0.1. What is the price at which the bank sells the loan? 4. MPC Suppose that nobody knows p, but everyone knows p is uniformly distributed over [.05.15] What is the market price of the loan? 5. Yes/No Suppose the bank knows the true value of p but outside investors only know that p is in the [.05,.15] range. Is there adverse selection? 6. Numerical. What price would we expect to see in the market? A bank has a loan that matures in 1 year and is risky. With probability p the loan defaults and the recovery value is 0.4. With probability 1-p the loan pays a gross return of 1.2. The expected future value of the loan (in one year) is thus 1.2*(1-p) + p*0.4 The bank discounts the loan at 10%. The value of the loan to the bank is thus (1.2*(1-p) + p*0.4)/1.1 The bank can sell the loan to competitive outside investors who discount at 7%. 3. MPC Suppose that everyone knows that p=0.1. What is the price at which the bank sells the loan? 4. MPC Suppose that nobody knows p, but everyone knows p is uniformly distributed over [.05.15] What is the market price of the loan? 5. Yes/No Suppose the bank knows the true value of p but outside investors only know that p is in the [.05,.15] range. Is there adverse selection? 6. Numerical. What price would we expect to see in the market?
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SOLUTION 3 MPC Suppose that everyone knows that p01 What is the price at which the bank sells the loan Since everyone knows that p01 the expected future value of the loan is EFV 12 1p p 04 12 101 01 0... View the full answer
Related Book For
Foundations of Finance The Logic and Practice of Financial Management
ISBN: 978-0132994873
8th edition
Authors: Arthur J. Keown, John D. Martin, J. William Petty
Posted Date:
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