Answer to Question #147669 in Economics for Owen Waite

Question

In this exercise, we examine the adverse selection issue discussed in the chapter. Call a the share of safe projects and (1-a) the share of risky projects. Assume that a safe project yields a return of Rs with 100% probability. Assume that a risky project yields a return of Rr with probability pr and a return of 0 with probability (1-pr). Assume the lender has perfect information about which projects are safe and which are risky. What is the minimum interest rate necessary to recover a loan of 1 with the safe project? What is the minimum interest rate necessary to recover a loan of 1 with the risky project? Assume that the lender cannot recognize which loans are safe and which are risky. What, then, is the minimum interest rate the bank must charge in order to recover a loan of 1? Above what interest rate would the safe projects stop demanding a loan?

Answer 1

Dear Owen Waite, your question requires a lot of work, which neither of our experts is ready to perform for free. We advise you to convert it to a fully qualified order and we will try to help you. Please click the link below to proceed: Submit order