1. Suppose the North American Bank has originated a portfolio of loans. North American knows that the aggregate payoff on this portfolio will be $100 with probability 0.9 and $30 with probability 0.1. Call this portfolio A. Investors, however, are unable to distinguish between this portfolio and another loan portfolio, call it B, that has an aggregate payoff of $100 with probability 0.7 and $30 with probability 0.3. Investors believe that there is a 0.5 probability that the portfolio is A, and an equal probability that it is B. There is universal risk neutrality. The cost to the bank of communicating the “true” value of its loan portfolio is $11; this can be viewed simply as a charge against the revenue from the sale of the loan portfolio. Think of this as a signaling cost ( Chapter 1 ) that declines with advances in information technology because these advances enable firms to resort to lower-cost signaling mechanisms. Also, North American’s net profit from loan origination and servicing is 1% of the value of the securitized loan portfolio, whereas if the loans are kept on the books and funded by the bank, the bank’s net profit is 2% of the “true” value of the loan portfolio minus a fixed cost of 99 cents associated with funding (this could represent, for instance, the sum total of regulatory taxes and administrative costs). Will North American prefer to securitize or fund its loan portfolio? Does your answer change if the communication cost drops from $11 to $2?