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  3. 1. credit and default consider the following very

1. Credit and default Consider the following very simple model of credit. A borrower...

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Finance

1. Credit and default
Consider the following very simple model of credit. A borrower needs a loan L from a lender.
The lenders gross cost of capital is r. That is, the lender faces an opportunity cost of Lr for
a loan of L. This model incorporates default risk. The loan will be repaid with probability
p. The lender lends at gross interest rate i. That is, a loan of L will be repaid iL if there is no
default. Compute the lenders expected profit by multiplying the profit in each state by the
probability that that state is happening.

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