Consider the two-period model with asymmetric information. Households deposit, D, in financial intermediaries (banks) and are paid the risk-free rate, r. Households take loans, L, from banks and pay the lending rate, rl. A fraction of households, p, pay back their debt, and a fraction, 1-p, default completely on their loans. Ex-ante banks know the fraction that repay, p, but cannot identify the individual households. Banks lend out all deposits. However, banks do not make zero profits but maintain positive profits such that profits = q*D where 0

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Consider the two-period model with asymmetric information. Households deposit, D,
in financial intermediaries (banks) and are paid the risk-free rate, r. Households take
loans, L, from banks and pay the lending rate, rl. A fraction of households, p, pay back
their debt, and a fraction, 1-p, default completely on their loans. Ex-ante banks know
the fraction that repay, p, but cannot identify the individual households. Banks lend
out all deposits. However, banks do not make zero profits but maintain positive
profits such that
profits = q*D
where 0<q<1 is some constant. Suppose that q=0.05, r=0.05, and p=0.9. What is the
lending rate, rl, that banks will charge?
0.222
0.275
0.278
0.167
0.375
Transcribed Image Text:Consider the two-period model with asymmetric information. Households deposit, D, in financial intermediaries (banks) and are paid the risk-free rate, r. Households take loans, L, from banks and pay the lending rate, rl. A fraction of households, p, pay back their debt, and a fraction, 1-p, default completely on their loans. Ex-ante banks know the fraction that repay, p, but cannot identify the individual households. Banks lend out all deposits. However, banks do not make zero profits but maintain positive profits such that profits = q*D where 0<q<1 is some constant. Suppose that q=0.05, r=0.05, and p=0.9. What is the lending rate, rl, that banks will charge? 0.222 0.275 0.278 0.167 0.375
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