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2. A borrowing country has a fluctuating level of output Y. Specifically, Y follows a uniform distribution U [16, 24]. Suppose the government takes out
2. A borrowing country has a fluctuating level of output Y. Specifically, Y follows a uniform distribution U [16, 24]. Suppose the government takes out a one-period loan L = 6 that carries an interest rate ri. This loan is supplied by competitive foreign creditors who have access to funds from world capital markets at risk free interest rate r = 0.125. The loan is due after output is realized. Suppose also that the government can only default on a fraction a = 0.6 of the loan, and if the government defaults on this fraction a, then it faces a cost equivalent to a fraction c = 0.25 of its output. (a) [2 points) Find ri >r offered by the competitive foreign investors? (b) (2 points) What is the probability that the government will repay its loan? (c) (1 points) Would the borrowing country default if ri =r? 2. A borrowing country has a fluctuating level of output Y. Specifically, Y follows a uniform distribution U [16, 24]. Suppose the government takes out a one-period loan L = 6 that carries an interest rate ri. This loan is supplied by competitive foreign creditors who have access to funds from world capital markets at risk free interest rate r = 0.125. The loan is due after output is realized. Suppose also that the government can only default on a fraction a = 0.6 of the loan, and if the government defaults on this fraction a, then it faces a cost equivalent to a fraction c = 0.25 of its output. (a) [2 points) Find ri >r offered by the competitive foreign investors? (b) (2 points) What is the probability that the government will repay its loan? (c) (1 points) Would the borrowing country default if ri =r
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