Consider two local banks. Bank A has 94 loans outstanding, each for $1.0 million, that it expects will be repaid today.

Consider two local banks. Bank A has 94 loans​ outstanding, each for $1.0 ​million, that it expects will be repaid today. Each loan has a 4%

probability of​ default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $94

million​ outstanding, which it also expects will be repaid today. It also has a 4% probability of not being repaid. Which bank faces less​ risk? Why?

A.

The expected payoffs are the​ same, but Bank A is less risky. I prefer Bank A.

B.

The expected payoff is higher for Bank​ A, but is riskier. I prefer Bank B.

C.

In both cases the expected loan payoff is the​ same:

$ 94 million times 0.96 equals $ 90.2 million$94 million×0.96=$90.2 million.

​Consequently, I​ don’t care which bank I own.

D.

The expected payoffs are the​ same, but Bank A is riskier. I prefer Bank B.

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