A customer has approached a local credit union for a $20,000 1-year loan at a 10

Question

A customer has approached a local credit union for a $20,000 1-year loan at a 10% interest rate. If the credit union does not approve the loan application, the $20,000 will be invested in bonds that earn a 6% annual return. The credit union believes that there is a 5% chance that this customer will default on the loan, assuming that the loan is approved. If the customer defaults on the loan, the credit union will lose the $20,000. What is the credit union's expected profit under the optimal decision?

Explanation / Answer

Return when loan is approved

= (5/100)*(-20000)+(95/100)*2000

= -1000+1900

= $1900

Return when loan is disappeared

= (20000*6/100)

= $1200

So, optimal strategy is R2 and return is $1200

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