Suppose that there is a household with $1 to lend. The household will be willing to...

 

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Suppose that there is a household with $1 to lend. The household will be willing to lend provided it gets at least $1 back in expectation. There are two entrepreneurs who need funding for a project - Zach and Dominic. If Dominic gets $1 of funding, his project will earn $1.15 with certainty and he pays back 1 + r to the lender. If Zach gets funding, with probability the project will succeed and he earns $1.8 and he pays back 1 + r to the lender; if the project fails it earns nothing and the lender loses the $1 of funding. Zach and Dominic will take a loan if the r is such that their expected profit is non-negative. (a) Suppose that the household/lender can tell Zach and Dominic apart. Which of them will be able to secure funding, and at what range of interest rate? (b) Now suppose that the household cannot tell Zach and Dominic apart. The household just knows that there is a probability p it is dealing with Dominic, and a probability 1 - p it is dealing with Zach. Solve for a value of p at which neither Zach nor Dominic will be able to get funding. Suppose that there is a household with $1 to lend. The household will be willing to lend provided it gets at least $1 back in expectation. There are two entrepreneurs who need funding for a project - Zach and Dominic. If Dominic gets $1 of funding, his project will earn $1.15 with certainty and he pays back 1 + r to the lender. If Zach gets funding, with probability the project will succeed and he earns $1.8 and he pays back 1 + r to the lender; if the project fails it earns nothing and the lender loses the $1 of funding. Zach and Dominic will take a loan if the r is such that their expected profit is non-negative. (a) Suppose that the household/lender can tell Zach and Dominic apart. Which of them will be able to secure funding, and at what range of interest rate? (b) Now suppose that the household cannot tell Zach and Dominic apart. The household just knows that there is a probability p it is dealing with Dominic, and a probability 1 - p it is dealing with Zach. Solve for a value of p at which neither Zach nor Dominic will be able to get funding.

Answer rating: 100% (QA)

a If the householdlender can tell Zach and Dominic apart then ... View the full answer