Question
10a. If the expected default rate on a credit card is 8.5% and the risk-free rate is 3.25%, what interest rate must a financial institution
10a. If the expected default rate on a credit card is 8.5% and the risk-free rate is 3.25%, what interest rate must a financial institution charge on the credit card in order for its expected return to equal the risk-free rate? If the financial institution assumes a 0% recovery rate in the event of default, what interest rate will the financial institution charge?
b. If the expected default rate on a 1-year home equity loan is 2.5% and the financial institution expects to recover 75% of the total loan return in the event of default, what rate must a financial institution charge on the automobile loan in order for its expected return to equal the risk free rate of 3.25%?
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