Question
SOVEREIGN DEFAULT A borrowing country has a fluctuating level of output Y. Specifically, Y follows a uniform distribution U[16,24]. Suppose the government takes out a
SOVEREIGN DEFAULT
A borrowing country has a fluctuating level of output Y. Specifically, Y follows a uniform distribution U[16,24]. Suppose the government takes out a one-period loan L= 5 that carries an interest rate rL. This loan is supplied by competitive foreign creditors who have access to funds from world capital markets at risk free interest rate r = 0.125. The loan is due after output is realized. Suppose also that the government can only default on a fraction = 0.6 of the loan, and if the government defaults on this fraction , then it faces a cost equivalent to a fraction c = 0.25 of its output.
(a) Find rL> r offered by the competitive foreign investors?
(b) What is the probability that the government will repay its loan?
(c) Would the borrowing country default if rL= r?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started
Macroeconomics Principles and Applications
Authors: Robert e. hall, marc Lieberman
5th edition
1111397465, 9781439038970, 1439038988, 978-1111397463, 143903897X, 9781439038987, 978-1133265238
