MATH 246 Quiz: Quiz 10 Solutions Fall 2008
14 Mar 2019
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Finance companies are firms that lend money to people and companies. Finance co. has 1000 zero-coupon, one-year loans outstanding, each for a face amount of. Goldfish co. has 10 zero-coupon, one-year loans outstanding, each for million. The face amounts of all the loans are due to be paid one year from today. Each loan has the same probability of default. Each loan has the same rate of loss in the event of default. Assume that the chance of default is completely idiosyncratic for each loan. Bluehorse : 1000 x 1mm x (expected fraction of loan"s face value that is repaid) Goldfish : 10 x 100mm x (expected fraction of loan"s face value that is repaid) A solution that briefly explains the intuition is sufficient. You may use a mathematical formula, but you do not need to use one. The standard deviation of the payoff on bluehorse"s payoff is less than that for goldfish because of diversification.
