A firm knows that it will have an opportunity to invest $100 at t=1 in either a safe (S) or risky (R) project. The bank is aware of the alternatives, but cannot observe which investment will be made. It may either lend at spot at t=1 or alternatively charge a commitment fee, and agree at t=0 to lend $100 at t=1 at a fixed rate. One year market interest rates are 10% at t=0 but could be either 5% or 15% at t=1 with equal probability. Investment opportunities: t=0 t=1 t=2 0.9 $150 S 0.1 $0 $100 02 $158 R 0.3 i=5% or 15% $0 i = 10% A firm knows that it will have an opportunity to invest $100 at t=1 in either a safe (S) or risky (R) project. The bank is aware of the alternatives, but cannot observe which investment will be made. It may either lend at spot at t=1 or alternatively charge a commitment fee, and agree at t=0 to lend $100 at t=1 at a fixed rate. One year market interest rates are 10% at t=0 but could be either 5% or 15% at t=1 with equal probability. Investment opportunities: t=0 t=1 t=2 0.9 $150 S 0.1 $0 $100 02 $158 R 0.3 i=5% or 15% $0 i = 10%