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3. Suppose that the lender could lend sufficient money so that $160,000 has to be repaid, but in one of two ways. It can
3. Suppose that the lender could lend sufficient money so that $160,000 has to be repaid, but in one of two ways. It can lend the money to one merchant, who needs to pay back the entire $160,000, or to 16 distinct merchants, each of which must repay $10,000. Due to its own credit obligations, the lender must have at least $60,000 of its money paid back within six months. Which approach would you recommend to management of the lender: lend to a single merchant or spread the money over 16 merchants? Support your choice by supplying an estimate of the probability that at least $60,000 will be paid back within six months under both scenarios. Your answer should note any key assumptions that are necessary for your analysis. The following questions will help guide your answer. (a) Which of the two models considered in questions 1 and 2 better conforms to the Simple Regression Model (SRM) assumptions? Briefly explain why. (b) Using the model from Q2, estimate the average PRSM of loans which must repay $10k and of loans which must repay $160k. (c) For each lending scheme, what is the smallest average PRSM that the lender must observe for each lending scheme to ensure $60k has been paid back within 6 months? (d) What is the approximate distribution of the average PRSM score in each of the two lending schemes? (e) For each lending scheme, determine the probability that at last $60k is paid back within 6 months. Which lending scheme is better - that is, which has the higher probability of repayment?
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