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We have a risk-neutral bank. Bank has a pool of loans that has a return of 10 with a probability of 0.6 and 2

 

We have a risk-neutral bank. Bank has a pool of loans that has a return of 10 with a probability of 0.6 and 2 with a probability of 0.4. If the bank holds the loans on its balance sheet it incurs a cost of 0.8 due to capital requirements. Banks can also securitize loans to overcome capital requirements. a) What is the maximum price a risk-averse buyer with u(x) = x1/3 would be willing to pay for the loan? Would the bank be willing to sell the loans in that case? b) Suppose, in addition to the risk-averse investors as in part a), there are also risk-neutral investors who are willing to buy the loans. However, risk-neutral investors have limited funds of 4.8. Would the bank be willing to sell the loans? How?

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