View the step-by-step solution to:

# In evaluating credit risk, discuss the statement: "An increase in collateral is a direct substitute for an increase in default risk.

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: Risk Premium with collateral:

where, k = required yield on a risky loan, i = 0.05 (default risk free interest rate), p = 0.95 (the probability that the loan will be paid in full in one year), (1-p) = 0.05 (probability of default over the year), and = 0.9 (the portion of the loan collateralized for certain).

(1-p) = 0.1 =&gt;p=1-.1=.9 credit risk premium on a one-year loan with collateral(γ = 0.9) = [(1+i) / (y+p - py)] - (1+i)=... View the full answer

### Why Join Course Hero?

Course Hero has all the homework and study help you need to succeed! We’ve got course-specific notes, study guides, and practice tests along with expert tutors.

### -

Educational Resources
• ### -

Study Documents

Find the best study resources around, tagged to your specific courses. Share your own to gain free Course Hero access.

Browse Documents