Suppose the estimated linear probability model used by an FI to predict business loan applicant default probabilities is PD  0.03 X1 0.02 X2  0.05 X3 error, where X1 is the borrower’s debt/equity ratio, X2 is the volatility of borrower earnings, and X3 is the borrower’s profit ratio. For a particular loan applicant, X1  0.75, X2  0.25, and X3  0.10.

a. What is the projected probability of default for the borrower?

b. What is the projected probability of repayment if the debt/equity ratio is 2.5?

c. What is a major weakness of the linear probability model?