1. DeBrusk & Heinen (D&H), Inc., can choose one of two projects: safe and risky. The safe project yields $141 with probability 0.9 and zero with probability 0.1, whereas the risky project yields $168 with probability 0.5 and zero with probability 0.5. Each project requires an investment of $100, which D&H must borrow. The bank can make only an unsecured loan, and cannot observe the firms choice of project. Agents are risk neutral, and the risk-free rate is zero. The highest interest rate the bank can charge and still have D&H choose the safe project is?

2. In order to break even by just covering the cost of funds the bank must charge approximately?

3. Now suppose the bank sells a long-term contract to D&H. The firm seeks two successive $100 loans to finance projects in periods 1 and 2. The bank promises to extend credit in period 2 on the condition that D&H repay its loan from period 1. The bank promises to charge which interest rate in period 2?

4. Suppose the bank in period 2 charges its preferred rate, i2. The maximum interest rate in period 1 that keeps the borrower safe can be found by solving which of the following equations?

5. The banks expected total cost of funds on the two-period contract equals?

6. The first period rate at which the bank breaks even (earns just the cost of funds) on the two-period contract is?

Thank you in advance!