Consider two local banks. Bank A has

83

loans outstanding, each for

$ 1.0

million, that it expects will be repaid today. Each loan has a

4 %

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

$ 83

million outstanding, which it also expects will be repaid today. It also has a

4 %

probability of not being repaid. Which bank faces less risk? Why?

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

B.In both cases the expected loan payoff is the same:

$ 83 million x 0.96 = $ 79.7 million

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

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

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