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Find risk premium with collateral

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Risk Premium with collateral:

In evaluating credit risk, discuss the statement: "An increase in collateral is a direct substitute for an increase in default risk." In your discussion, evaluate the credit risk premium on a one-year loan with and without collateral using the following formula and values:

where, k = required yield on a risky loan,

i = 0.1 (default risk free interest rate),

(1-p) = 0.05 (probability of default over the year), and

g = 0.8 (the portion of the loan collateralized for certain).

Reference no: EM132731539

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