Consider two local banks. Bank A has 100 loans outstanding, each for $1.0 million, that it expects will be repaid today. Each loan has a 6% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 6% probability of not being repaid. Which bank faces less risk? Why?

(Select the best choice below.)

A.

The expected payoffs are the same, but Bank A is less risky. I prefer Bank A.

B.

The expected payoff is higher for Bank A, but is riskier. I prefer Bank B.

C.

The expected payoffs are the same, but Bank A is riskier. I prefer Bank B.

D.

In both cases, the expected loan payoff is the same: $100 million0.94=$94.0 million.

Consequently, I don't care which bank I own.