A bank is able to diversify between two independent loans, Ask an Expert

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A bank is able to diversify between two independent loans ($1M each) with 30% probability of default. In case of default the recovery rate on a loan is equal to the residual value of investment project undertaken by the borrower. The recovery rate is equal to 90%, but is unobservable to the lender without monitoring. Monitoring the borrower costs $150. The bank depositors are riskneutral and are ready to lend at 5% expected rate of return. They deposit $100 each.

(A) Determine interest rates on deposits and loans.

(B) Calculate the banker control rent (profit) and delegation cost per borrower.

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M92842022

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