Question: A bank uses a linear probability model for predicting the probability of default for loan applicants: PD = 0.12(D/E) 0.38(PM), where D/E is the applicants

  1. A bank uses a linear probability model for predicting the probability of default for loan applicants: PD = 0.12(D/E) 0.38(PM), where D/E is the applicants debt to equity ratio and PM is the applicants profit margin. Based on their respective probability of default, which of the following two applicants is the better risk for the bank? Why?
  • Applicant 102, with a debt to equity ratio of 2.12 times and a 15% profit margin
  • Applicant 217, with a debt to equity ratio of 1.67 times and an 8% profit margin

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