Consider the following lending contract between a farmer and a bank, both of whom are riskñneutral....

Consider the following lending contract between a farmer and a bank, both of whom are riskñneutral. The farmer needs to borrow $120 in order to buy seeds for a new crop that she has not grown before. If she puts in the e§ort needed to learn how to cultivate the crop properly, her investment will pay o§ for sure and generate a crop yielding a value of $300. However, if she does not put in this e§ort the crop yield is uncertain. SpeciÖcally, her yield will be $300 with probability 0:5, but may end up being 0 with probability 0:5. The value of the time needed to learn about the correct cultivation methods is assumed to be 80 and the net cost per dollar lent for the bank is 30%. The bank must decide what repayment R it will require as part of the contract. Assume that the borrower has limited liability and no collateral. (a) For a given repayment R, what is the expected income of the borrower if she learns about the crop? What is her expected income if she does not learn? (b) Use your answer to part (a) to derive the maximum repayment R that the bank can charge while still inducing the borrower to learn. Will the bank make the loan ? Suppose now that two such borrowers form a group and borrow from the bank under a joint liability clause. Assume also that the borrowers act in unison so as to maximize their joint expected payo§. (c) For a given repayment R, what is the expected joint income of the borrowers if they both learn about the correct method? What is their expected joint income if they do not learn? (d) Derive the maximum repayment, R, that the bank can charge while still inducing borrowers to learn. Will the bank make the loan now?

Expert Solution

Rahul Sunny answered 1 year ago

Consider a loan contract signed between a lender (e.g., a bank) and a borrower. Would the...

Consider a loan contract signed between a lender (e.g., a bank) and a borrower. Would the lender benefit or lose from inflation in the country? Explain your reasoning in a few sentences.

Consider a farmer who is trying to choose between a coinsurance policy and a deductible policy...

Consider a farmer who is trying to choose between a coinsurance policy and a deductible policy to protect against damage to her farming lands. The value of the loss, and the corresponding probabilities of each value, are given as follows: L = 0 with prob. 0:4 10; 000 with prob. 0:2 20; 000 with prob. 0:05 40; 000 with prob. 0:05 60; 000 with prob. 0:05 80; 000 with prob. 0:05 100; 000 with prob. 0:15 220; 000 with prob....

A farmer must choose between two possible investments that both require an initial outlay of $120,000...

A farmer must choose between two possible investments that both require an initial outlay of $120,000 and will have no salvage value at the end of their economic life (3 years). The first investment is expected to yield annual net cash flows of $55,000 over a 3-year planning horizon. The second will yield $30,000 in the first year, $40,000 in the second and $50,000 in the third. -The farmer finances 50% of the investment with an outside loan (interest rate...

A Spanish commercial bank is engaged in the following foreign lending/borrowing and trading activities in U.S...

A Spanish commercial bank is engaged in the following foreign lending/borrowing and trading activities in U.S dollar: a) The bank owns $5,000,000 value of corporate bonds in U.S company b) The bank has lent an U.S. company an amount of $16,000,000 c) The bank has borrowed $8,000,000 from a American bank d) The bank has sold $300,000 to a Spanish customer to facilitate acquisition of raw materials from U.S supplier. e) The bank has purchased $4,000,000 from Spanish investor who...

Which of the following Fed actions will increase bank lending? Select one or more answers from...

Which of the following Fed actions will increase bank lending? Select one or more answers from the choices shown The Fed lowers the discount rate from 4 percent to 2 percent The Fed raises the reserve ratio from 10 percent to 11 percent The Fed raises the discount rate from 5 percent to 6 percent The Fed sells bonds to commercial banks

Which of the following actions will increase bank lending? Instructions: You may select more than...

Which of the following actions will increase bank lending? Instructions: You may select more than one answer. Click the box with a check mark for correct answers and click to empty the box for the wrong answers. The Bank of Canada buys $400 million worth of bonds from chartered banks. The chartered banks raise the desired reserve ratio from 10 to 11 percent. The Bank of Canada lowers the bank rate from 4 to 2 percent. The Bank of...

Consider a society consisting of just a farmer and a tailor. The farmer has 30 units...

Consider a society consisting of just a farmer and a tailor. The farmer has 30 units of food but no clothing. The tailor has 60 units of clothing but no food. Suppose each has the utility function U=F^1/3C^2/3 . If the price of clothing is always $1, and the food price is currently $1, then we can conclude Question 10 options: the market is at a competitive equilibrium. the price of food will drop towards a competitive equilibrium. the price...

The U.S. Commerce Bank in St. Louis is trying to expand its overseas bank lending market....

The U.S. Commerce Bank in St. Louis is trying to expand its overseas bank lending market. Now it has the opportunity to provide a profitable loan to the UK subsidiary of the local HGF Corporation. However, the bank has to obtain 50 Million PS for three months right away to fund the foreign loan, which will be repaid back in Pound Sterling (PS). The CFO has taken an international banking seminar and is aware of the Eurocurrency market that can...

Consider a farmer and a rancher who operate near one another. The farmer grows crops and...

Consider a farmer and a rancher who operate near one another. The farmer grows crops and the rancher’s herd wanders and tramples the farmer’s crops. If the herd tramples the crops, it causes $400 per week worth of damage to the farmer. The rancher could put a fence around the herd to prevent damage to the crops, but the cost for the rancher to build and maintain the fence is $500 per week. The farmer could protect his crops with...

A farmer is considering borrowing money from a bank. Given the following information: Initial loan amount...

A farmer is considering borrowing money from a bank. Given the following information: Initial loan amount is $88,000. The loan will be fully amortized in 3 years at 12%. Marginal tax rate is 20%. (i) What is the interest payment in the 1st year? a. $12,672.00 b. $13,200.00 c. $10,560.00 d. None of the answers are correct (ii) What is the principal payment in the 1st year? a. $20,862.97 b. $20,041.13 c. $4,400.00 d. $26,078.71...

Question