1. Kelvin intends to buy a new property. He is considering two options :

(i) Pay for the mortgage insurance that insures the lender in case of the default of the borrower), or,

(ii) Pay the lender a higher interest rate for the mortgage.

a. Explain how these two options are related to the risk premium concept and the lenders risk aversion. (10 marks)

b. Discuss the ways that insurance company or the lender may use to reduce their risk from the borrower ? (10 marks)