Question
Suppose a bank pools the money of two investors (A and B), each contributing $100. There is a 5% chance that either one of the
Suppose a bank pools the money of two investors (A and B), each contributing $100. There is a 5% chance that either one of the investors needs cash after year 1. The probability that they need cash after year 1 is independent of each other. Otherwise, they will need money in year 2. The bank keeps $100 in cash that earns zero interest rate, and it lends the remaining $100 to a borrower who promises to pay $120 at time 2. Assume there is no default risk with the borrower. However, if the borrower's project gets liquidated at year 1, the project gets only $40 back (called liquidation value) at year 1.
Please answer the following questions based on this information. Only numbers, rounded to two decimal places when applicable, are necessary.
1-)What is the probability (in %) that only A needs money at year 1? 2-) What is the probability (in %) that only B needs money at year 1? 3-) What is the probability (in %) that no one needs money at year 1? 4-) What is the probability (in %) that both need money at year 1? 5-) What is the expected cash flow to both investors combined at time 1? 6-) What is the expected cash flow to both investors combined at time 2? 7-) Assuming a discount rate of 5%, what is the NPV of these cash flows? 8-) What is the minimum payoff in year 2 that the borrower would have to promise to pay in order to make this a zero-NPV project to the bank?
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