in that case there will be no funds available to pay either the

In that case there will be no funds available to pay

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; in that case, there will be no funds available to pay either the depositors/bondholders or the shareholders. In other states of the world, the loans pay off as in part a. If depositors/bondholders are risk neutral, what total rate of return 𝑅 will they require in the no- default state if they are to be willing to provide funds to the bank? Use your result to calculate the volume of loans extended and funds borrowed by the bank. How do your results compare with part a.? c. Now suppose the government stands ready to bail-out the depositors/bondholders in the event of a default on the loans. What rate of return will depositors/bondholders demand from the bank? What will be the quantity of loans extended and funds borrowed? Compare your answers with parts a. and b. How big is the government subsidy to the depositors/bondholders in the event of default? Explain your results. 3. Bank regulation a. It is said that the normal commercial disciplines of bankruptcy cannot be applied to banks. Why not? What does your answer imply for bank regulation policy? b. Banks claim that requiring them to hold more capital will add to their costs, and hence oblige them to charge higher interest on their loans. Evaluate this claim.
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