Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
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Chapter 10, Problem 20P
Consider two local banks. Bank A has 100 loans outstanding, each for $1 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Explain the difference between the type of risk each bank races. Which bank faces less risk? Why?
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Consider two local banks. Bank A has 95 loans outstanding, each for $1.0 million, that it expects will be repaid today. Each loan has a 4% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $95 million outstanding, which it also expects will be repaid today. It also has a 4% probability of not being repaid. Which bank faces less risk? Why?
A. The expected payoff is higher for Bank A, but is riskier. I prefer Bank B.
B. The expected payoffs are the same, but Bank A is less risky. I prefer Bank A.
C. In both cases, the expected loan payoff is the same: $95 million×0.96=$91.2 million. Consequently, I don't care which bank I own.
D. The expected payoffs are the same, but Bank A is riskier. I prefer Bank B.
Consider two local banks. Bank A has 83 loans outstanding, each for $1.0 million, that it expects will be repaid today.
Each loan has a 3% probability of default, in which case the bank is not repaid anything. The chance of default is
independent across all the loans. Bank B has only one loan of $83 million outstanding, which it also expects will be
repaid today. It also has a 3% probability of not being repaid. Which bank faces less risk? Why?
(Select the best choice below.)
O A. The expected payoff is higher for Bank A, but is riskier. I prefer Bank B.
B. The expected payoffs are the same, but Bank A is less risky. I prefer Bank A.
C. The expected payoffs are the same, but Bank A is riskier. I prefer Bank B.
D. In both cases, the expected loan payoff is the same: $83 million x 0.97 = $80.5 million. Consequently, I don't
care which bank I own.
Consider two local banks. Bank A has 77 loans outstanding, each for $1.0 million, that it expects will be repaid today. Each loan has a 4%
probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has
only one loan of $77 million outstanding, which it also expects will be repaid today. It also has a 4% probability of not being repaid.
Calculate the following:
a. The expected overall payoff of each bank.
b. The standard deviation of the overall payoff of each bank.
Chapter 10 Solutions
Corporate Finance
Ch. 10.1 - Prob. 1CCCh. 10.1 - Prob. 2CCCh. 10.2 - Prob. 1CCCh. 10.2 - Prob. 2CCCh. 10.3 - How do we estimate the average annual return of an...Ch. 10.3 - Prob. 2CCCh. 10.4 - Prob. 1CCCh. 10.4 - Do expected returns of well-diversified large...Ch. 10.4 - Do expected returns for Individual stocks appear...Ch. 10.5 - What is the difference between common risk and...
Ch. 10.5 - Prob. 2CCCh. 10.6 - Explain why the risk premium of diversifiable risk...Ch. 10.6 - Why is the risk premium of a security determined...Ch. 10.7 - What is the market portfolio?Ch. 10.7 - Define the beta of a security.Ch. 10.8 - Prob. 1CCCh. 10.8 - Prob. 2CCCh. 10 - Prob. 1PCh. 10 - Prob. 2PCh. 10 - Prob. 3PCh. 10 - Prob. 4PCh. 10 - Prob. 5PCh. 10 - Prob. 6PCh. 10 - The last four years of returns for a stock are as...Ch. 10 - Prob. 8PCh. 10 - Prob. 9PCh. 10 - Prob. 10PCh. 10 - Prob. 11PCh. 10 - How does the relationship between the average...Ch. 10 - Consider two local banks. Bank A has 100 loans...Ch. 10 - Prob. 21PCh. 10 - Prob. 22PCh. 10 - Consider an economy with two types of firms, S and...Ch. 10 - Prob. 24PCh. 10 - Explain why the risk premium of a stock does not...Ch. 10 - Prob. 26PCh. 10 - Prob. 27PCh. 10 - What is an efficient portfolio?Ch. 10 - What does the beta of a stock measure?Ch. 10 - Prob. 31PCh. 10 - Prob. 32PCh. 10 - Prob. 33PCh. 10 - Suppose the risk-free interest rate is 4%. a. i....Ch. 10 - Prob. 35PCh. 10 - Prob. 36PCh. 10 - Suppose the market risk premium is 6.5% and the...Ch. 10 - Prob. 38P
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