Consider an economy where Banks can invest in one of two projects, G and B. Project G pays G if successful and zero if not successful and has a probability of success ag. Project B pays B if successful and zero if not successful and has a probability of success TB. Suppose also that project G requires an additional cost of c. Assume that banks are required to hold an amount of capital k for each unit of investment. Banks are financed by short term investors who are risk neutral and who require an expected rate of return equal to the risk free rate which is zero. Capital is costly because its holders can demand a rate of return of p > 0 and so the profit of a bank is given by either TG(G-(1-k)R)-C-(1+p)k or ab(B-(1-k)R) - (1+p)k depending on what project is invested in Suppose that G = 8, B = 14, TG = 5, B = {and c == 1. If k = 0, i.e. banks are not required and to hold any capital, what is the critical level of interest rates above which the bank will choose to invest in the bad project? Options: A. 3/4 B. 4/5 C. 5/4 D. 4/2 E. None of A-D

ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
icon
Related questions
Question

Please Help Me ASAP. Thanks

Consider an economy where Banks can invest in one of two projects, G and B. Project G pays G if successful and zero if not successful and has a probability of
success ag. Project B pays B if successful and zero if not successful and has a probability of success TB. Suppose also that project G requires an additional cost
of c. Assume that banks are required to hold an amount of capital k for each unit of investment. Banks are financed by short term investors who are risk
neutral and who require an expected rate of return equal to the risk free rate which is zero. Capital is costly because its holders can demand a rate of return
of p>0 and so the profit of a bank is given by either TG(G - (1 - k)R) -C-(1+p)k or ab(B - (1 - k)R) - (1+p)k depending on what project is invested in Suppose that
G = 8, B = 14, TG = 5, B = { and c = = 1. If k = 0, i.e. banks are not required and to hold any capital, what is the critical level of interest rates above which the
bank will choose to invest in the bad project? Options: A. 3/4 B. 4/5 C. 5/4 D. 4/2 E. None of A-D
Transcribed Image Text:Consider an economy where Banks can invest in one of two projects, G and B. Project G pays G if successful and zero if not successful and has a probability of success ag. Project B pays B if successful and zero if not successful and has a probability of success TB. Suppose also that project G requires an additional cost of c. Assume that banks are required to hold an amount of capital k for each unit of investment. Banks are financed by short term investors who are risk neutral and who require an expected rate of return equal to the risk free rate which is zero. Capital is costly because its holders can demand a rate of return of p>0 and so the profit of a bank is given by either TG(G - (1 - k)R) -C-(1+p)k or ab(B - (1 - k)R) - (1+p)k depending on what project is invested in Suppose that G = 8, B = 14, TG = 5, B = { and c = = 1. If k = 0, i.e. banks are not required and to hold any capital, what is the critical level of interest rates above which the bank will choose to invest in the bad project? Options: A. 3/4 B. 4/5 C. 5/4 D. 4/2 E. None of A-D
Expert Solution
steps

Step by step

Solved in 3 steps with 5 images

Blurred answer
Knowledge Booster
Investments
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.
Recommended textbooks for you
ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
Economics
ISBN:
9780190931919
Author:
NEWNAN
Publisher:
Oxford University Press
Principles of Economics (12th Edition)
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education