Consider two local banks. Bank A has 99 loans outstanding, each for $1.0 million
ID: 2738904 • Letter: C
Question
Consider two local banks. Bank A has 99 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 $99 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? (Select the best choice below.) A. In both cases the expected loan payoff is the same: $99 million times 0.96 = $95.0 million. Consequently, I don't care which bank I own. B. The expected payoffs are the same, but Bank A is less risky. I prefer Bank A. C. The expected payoff is higher for Bank A, but is riskier. I prefer Bank B. D. The expected payoffs are the same, but Bank A is riskier. I prefer Bank B.Explanation / Answer
Both the banks have same expected pay off i.e. 96 % of loan amount i.e. .96 * 99 m=95 000000
Hence, both banks face equal risk.