Consider an individual who plans to buy a new home. He has two options: (i) pay for mortgage insurance (that insures the lender in case the borrower defaults), or (ii) pay the lender a higher interest rate for the mortgage. Describe how these two options are related to the concept of risk premium and the lender's aversion to risk. Why does the interest rate on the mortgage differ in these two options?
What will be an ideal response?
In option (ii), the risk premium on the mortgage is positive because the lender realizes there is some risk in the homeowner's ability to repay the loan. Therefore, the borrower will have to pay the risk premium in order to obtain a mortgage from the lender. If the homeowner takes option (i), he pays no premium to the lender. This is because the policy holder is paying someone else to take the risks associated with the mortgage. This is why the borrower will not need to pay a risk premium to the lender in option (i). If the borrower pays a risk premium to the mortgage lender, the lender takes on the risk (option i). If the borrower pays for insurance, then the insurance company takes the risk (option ii).
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Marginal profit is negative when:
A) marginal revenue is negative. B) total cost exceeds total revenue. C) output exceeds the profit-maximizing level. D) profit is negative.
In an uncertain world, private investors
a. always make decisions that lead to economic profit. b. never make decisions that generate economic losses. c. sometimes make decisions that lead to economic losses. d. rarely invest in human capital.