A financial intermediary (FI) has been borrowing overnight, from just two lenders, to fund purchases of relatively illiquid bonds. Each lender has been lending $D to the FI. Every morning, each lender has to decide whether to roll over his loan to the FI, or to withdraw his loan.

a) 10 pts. Suppose that, if both lenders to the FI choose to roll over, the FI remains in business and will repay both lenders with interest: each lender will receive (1 ) + i D . If either or both of the lenders withdraws, the FI must immediately sell its bonds at low prices. In that case, each lender receives a fraction z of the money that is owed him, where z is less than one. That is to say, if one withdraws and the other doesn't, the lender who withdraws gets zD; the lender who rolls over gets z i D (1 ) + . If both withdraw, each gets zD. Make a "box" to describe this situation. In each of the four segments of the box, list what is received by "lender A" and "lender B." Circle the segment(s) of the box that is (are) an equilibrium.

b) 10 pts. Now suppose that the lenders to the FI have credit default swaps on the FI. If both lenders roll over, each lender will receive (1 ) + i D . If one withdraws and the other doesn't, the lender who withdraws gets D; the lender who rolls over gets (1 ) + i D . If both withdraw, each gets D. Make a "box" to describe this situation. In each of the four segments of the box, list what is received by "lender A" and "lender B." Circle the segment(s) of the box that is (are) an equilibrium.