Consider the model of Moral Hazard where firms choose between investing one unit of output in a less risky or more risky project. The safer project yields with probability and zero otherwise while the risky project yields 2 with probability and zero otherwise i.e. πg = £ G = ³ πb=B=2. Suppose firms finance their investment by borrowing 1 10 10 unit from a the fiinancial market at interest rate R. The financial market is risk neutral and requires an expected rate of return equal to the risk free rate which is assumed to be zero. Will there be an equilibrium with lending to firms from the financial market D. None of A-C A. Yes B. No C. Not enough information

Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter12: Capital Budgeting: Decision Criteria
Section: Chapter Questions
Problem 11P
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2. Consider the model of Moral Hazard where firms choose between investing one unit of
output in a less risky or more risky project. The safer project yields with probability
and zero otherwise while the risky project yields 2 with probability and zero otherwise
i.e. TG = G = TB B = 2. Suppose firms finance their investment by borrowing 1
unit from a the fiinancial market at interest rate R. The financial market is risk neutral and
requires an expected rate of return equal to the risk free rate which is assumed to be zero.
Will there be an equilibrium with lending to firms from the financial market
A. Yes B. No C. Not enough information D. None of A-C
Transcribed Image Text:2. Consider the model of Moral Hazard where firms choose between investing one unit of output in a less risky or more risky project. The safer project yields with probability and zero otherwise while the risky project yields 2 with probability and zero otherwise i.e. TG = G = TB B = 2. Suppose firms finance their investment by borrowing 1 unit from a the fiinancial market at interest rate R. The financial market is risk neutral and requires an expected rate of return equal to the risk free rate which is assumed to be zero. Will there be an equilibrium with lending to firms from the financial market A. Yes B. No C. Not enough information D. None of A-C
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