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Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.
-Given the answer in 21, should the bank securitize the portfolio with or without communication compare the net payoff)?
A)With communication, since it is better off by $15.
B)With communication, since it is better off by $20.
C)With communication, since it is better off by $60.
D)Without communication, since it is better off by $15.
E)Without communication, since it is better off by $45.

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Suppose that the Third United Bank has originated a portfolio of loans.The bank knows that the aggregate payoff on this portfolio call this portfolio S will be $1,000 with probability 0.7 and $400 with probability 0.3.However, investors are unable to distinguish portfolio S from portfolio R.Portfolio R has an aggregate payoff of $1,000 with probability 0.5 and $400 with probability 0.5.Nevertheless, the investors believe that there is a 0.5 probability that the portfolio is S.The cost of communicating the true value of the portfolio is $75.If the bank keeps the portfolio on the books, its net profit is 7% of the true value minus a fixed cost of
$25.The bank's net profit from origination and servicing is 4% of the value of the securitized portfolio.Everybody is risk-neutral.
-Given the answer in 21, should the bank securitize the portfolio with or without communication compare the net payoff)?
A)With communication, since it is better off by $15.
B)With communication, since it is better off by $20.
C)With communication, since it is better off by $60.
D)Without communication, since it is better off by $15.
E)Without communication, since it is better off by $45.

Quizplus · Accepted Answer

Without communication, the expected value of the portfolio to investors is calculated as follows: 0.5 probability of being S (with a 0.7 probability of $1,000 and a 0.3 probability of $400) and a 0.5 probability of being R (with a 0.5 probability of $1,000 and a 0.5 probability of $400). This results in an expected value of $700 for S and $700 for R, making the overall expected value $700. The bank's net profit from securitization without communication is 4% of $700, which is $28. With communication, the bank can reveal it's portfolio S, but after the $75 communication cost, the net profit is lower than without communication. Therefore, the bank is better off by $15 without communication, as it avoids the communication cost and still realizes a profit from securitization.

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