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Discuss difference between types of risk each bank faces

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Consider two local banks. Bank A has 100 loans outstanding, each for $1million, which it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all loans. Bank B has only one loan of $100million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid.

Question 1: Explain the difference between the types of risk each bank faces. Assuming you are risk averse, which bank would you prefer to own?

Reference no: EM132523094

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