7. Consider an economy with a population of entrepreneurs, each of which owns a single project...

 

 

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7. Consider an economy with a population of entrepreneurs, each of which owns a single project that requires an up-front investment of 100. The fraction 0 < p < 1 of entrepreneurs own Project 1 and 1-p own Project 2. The payoff-profiles of the two projects are Project 1 outcome payoff probability 120 0 success failure -19-12 10 Project 2 outcome payoff probability success 162 failure 0 In the event of failure, the borrower "walks away" and pays nothing to the lender. (a) Find the "break-even" interest rate for the owners of each project. (The break-even interest rate generates exactly zero profit for the borrower.) (b) Find the break-even interest rate for a lender to Project 1, and the break- even rate for a lender to Project 2. (c) Suppose that lenders can distinguish between borrowers (so that there is no asymmetry of information). Which projects will be funded? Does the value of p matter? (d) Suppose instead that an entrepreneur knows which project he/she owns, but lenders cannot distinguish between projects. Let p= . Find the break-even interest rate for a lender who lends to owners of both types of project (remember that since the lender cannot tell one project from another, he/she must charge the same rate to all.) (e) Show that in the case of asymmetric information, it is impossible for the lender to finance all projects in such a way that all borrowers and lenders are profitable. Which projects are forced to leave the market? 7. Consider an economy with a population of entrepreneurs, each of which owns a single project that requires an up-front investment of 100. The fraction 0 < p < 1 of entrepreneurs own Project 1 and 1-p own Project 2. The payoff-profiles of the two projects are Project 1 outcome payoff probability 120 0 success failure -19-12 10 Project 2 outcome payoff probability success 162 failure 0 In the event of failure, the borrower "walks away" and pays nothing to the lender. (a) Find the "break-even" interest rate for the owners of each project. (The break-even interest rate generates exactly zero profit for the borrower.) (b) Find the break-even interest rate for a lender to Project 1, and the break- even rate for a lender to Project 2. (c) Suppose that lenders can distinguish between borrowers (so that there is no asymmetry of information). Which projects will be funded? Does the value of p matter? (d) Suppose instead that an entrepreneur knows which project he/she owns, but lenders cannot distinguish between projects. Let p= . Find the break-even interest rate for a lender who lends to owners of both types of project (remember that since the lender cannot tell one project from another, he/she must charge the same rate to all.) (e) Show that in the case of asymmetric information, it is impossible for the lender to finance all projects in such a way that all borrowers and lenders are profitable. Which projects are forced to leave the market?

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a Find the break even interest rate for the owners of each project The break even interest rate generates exactly zero profit for the borrower ANS WER ... View the full answer