Suppose the estimated linear probability model used by an FI to pre- dict business loan applicant default probabilities is PD = .03X + .02X- .05X3+ error, where X 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, X = 0.75, X = 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?

 LO.1