a. Assume that firms issue risky bonds to fund investment that will expand their plant size. When the policy rate of interest rate is 4% and the probability of bankruptcy is 3%, what is the premium? (Explain how you got your answer. Round your response two decimal places)

b. Consider the simplified bank balance sheet shown below:

Bank Balance Sheet

Assets 180

Liabilities 160

Capital 20

if the bank assets decline in value, keeping liabilities constant, capital will............... and leverage ratio will....... (fill in the blank twice in the sentence)

In the bank balance sheet above, suppose the Return on Assets is 4% and the Payment of Interest on liabilites is 2%. What is the return on capital for the banknnoc? (Explain how you got your answer. Indicate the return in%)