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Find the possible ranges of the market interest rate

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Reference no: EM131022325

Week 8

1. List the three main components of the Glass-Steagall Act of 1933 and explain why this act was passed.

2. Describe in more detail the rationale behind the three main components of the Glass-Steagall Act when this act was passed in 1933.

3. Explain what disintermediation is and which component of the Glass-Steagall Act is related to this concept.

4. Explain which component of the Glass-Steagall Act is related to the concept of moral hazard and describe how it is related.

5. Consider the following scenario. A bank is a potential supplier of loans to two types of firms. One firm is a safe firm while the other is risky (more likely to default on its loan payments). The risky firm is willing to pay an interest rate on loans granted by the bank of up to 20%. The safe firm will accept interest rates up to 10%. If the bank know which of the two firms it is dealing with (i.e. it has "perfect information" about firm type) when considering whether to grant a loan, it must charge the risky firm an interest rate of at least 18% and the safe firm an interest rate of at least 4%. Now, assume the bank does not know which type of firm of firm it is dealing with but that it does know the information in the tables given below. Moreover, assume each firm knows its own type. Find the possible range(s) of the market interest rate in the following three scenarios below and discuss who is in the market and who is driven out of the market.

a)

 

# of Firms

Value to Borrower

Value to Lender

Risky firm

1

15%

8%

Safe firm

1

5%

4%

b)

 

# of Firms

Value to Borrower

Value to Lender

Risky firm

1

15%

8%

Safe firm

2

5%

4%

c)

 

# of Firms

Value to Borrower

Value to Lender

Risky firm

1

15%

8%

Safe firm

4

5%

4%

Reference no: EM131022325

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