Notice that should your private risk (q) realizes the bonus in the bargain will get 0. Up coming precisely the inspired debtors tend to pay-off early, if your ex lover blog post interest remains high. However in happening away from a lessening interest rate all the debtors will pay back very early. Those for which the benefit on offer stays b have a tendency to repay very early or take up an alternate borrowing at the a diminished interest. The others, having exactly who the look at this web-site non-public risk has knew also pay off early. In their mind the newest gain regarding bargain might be 0.

They reinvests the fresh paid back financing in one rate of interest just like the brand new credit rate

In the model a risk premium exists only for the first credit and not for the second credit. If the debtor takes up the second credit at the low interest rate ( \(_<2l>)\) the interest rate cannot-by assumption-decline any more in future. The bank cannot impose a risk premium on the second credit, because the bank has no damage if the second credit is also prematurely repaid. [Read more…]