Please ans E Question 4Bank issues two loans. Each loan yields a return R with probability p and O otherwise. Probabilitiesof success of individual loans are independently and identically distributed (i.i.d.).The bank finances the loan with equity (k) and debt (d). Debt has a net cost of 0 (bank debtorsbreak-even in expectation). Equity is costly, where 1 unit of bank equity costs c>1.a) Suppose the keeps the loans on its balance sheet. What is the expected profit that the bankmakes?Expected return from each loan is pR. For each loan, bank needs to hold equity k and d=1-k, wherethe cost of equity is ck.Expected profit = 2pR – 2(1-k) – 2ck = 2pR - 2-2k(c-1).For the rest, suppose that R = 4, p = 0.5, k= 0.5 and c= 2.5b) What is the expected profit of the bank in this case from holding the two loans on its balancesheet?c) Suppose the bank wants to avoid capital costs and securitizes the two loans. Bank sells the loansindividually to risk-averse investors with utility functions U(R) = R. What is the revenue that thebank would get if it sold 2 loans to two risk-averse investors?d) Bank can pool the two loans and create two securities by splitting equally the claims on the cashflows. What is the maximum price the risk-averse investors would be willing to pay for such asecurity and would the bank be willing to pool and sell the loans?e) What happens when the bank issues N loans with N0 and each investor acquires a share of1/N in the loan portfolio?

The term loan alludes to a sort of credit vehicle where an amount of cash is loaned to one more…

Answered: e) What happens when the bank issues N…

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e) What happens when the bank issues N loans with N0 and each investor acquires a share of 1/N in the loan portfolio?

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.7P

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