23 Jul HOW MUCH EQUITY IS REQUIRED TO ELIMINATE THE MORAL HAZARD?
Assume that firms have their choice of investment project. A safe investment of $100 turns into $1 Show more Assume that firms have their choice of investment project. A safe investment of $100 turns into $110 with certainty. A risky investment is equally likely to turn $100 into $200 or $0. The cost of funds is 4%. Information is asymmetric. How does the expected profit from the risky project compare to that of the safe project? In equilibrium the bond market does not exist. Why? How much equity is required to eliminate the Moral Hazard? . What is the minimum amount of collateral that eliminates the Moral Hazard? . True or false: In this model the purpose of collateral is to compensate the lender in the event of default. Show less
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