Question
A single bank is considering two options: First, it can make a $200,000 mortgage loan for a customer with a 10 percent probability of
A single bank is considering two options: First, it can make a $200,000 mortgage loan for a customer with a 10 percent probability of default, or second, it can buy a $200,000 security representing a bundle of 100 mortgage loans, which break down as shown in the table below. You can calculate the weighted risk for each firm category by multiplying the percentage of loans represented (for example, the first tier includes 40 loans, which is 40/100 = 40% of the total) times the probability of default on loans of that category. Instructions: Round your answers to three decimal places. a. Calculate the weighted risk for each type of loan, then add together the weighted risks to come up with an overall expected default risk for this financial investment. Number of Loans Probability of Default () Weighted Risk 40 3 20 11 15 25 1.5 4.5 Adding together the weighted risks, the expected default risk for the security is: [ %. b. If the bank is willing to take on only projects for which the default risk is 6% or less, it should choose the (Click to select)
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