Answer with explanation You are a banker with $2 million cash. A client wants to

Question

Answer with explanation

You are a banker with $2 million cash. A client wants to conduct a LBO (Leveraged Buyout: management of a company gain controlling share using outside capital) and ask you how much money can you promise to loan her. She needs a lot of money and is in touch with multiple banks. The return of this loan will be 10% in three months. Pending on last minute negotiation, her final loan need from you will be $200,000 to $600,000 (uniformly distributed) less than the number you promise her. If her final loan request is less than the $2 million you have, you will use the extra cash to purchase 3-month U.S. Treasure Bill and earn 2%. If her final loan need is more than you actually have, you will borrow from a loan shark at 20% for the three months to cover the gap. She is waiting on the line, how much money can you promise her?

Explanation / Answer

Answer:-

Return on loan = 10% in 3 months

1. Pay less than $2 million

i,ll use extra cash to purchase treasure bill & earn 2%.

2. Pay more than $2 million (which is more than actually i have)

in case i,ll borrow money from loan shark at 20% for 3 months.

( Ist option is best, because Return on loan provided to her = 10% in 3 months & Return on extra money invested in treasure bill =2% )

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