Question

Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a​ 5% interest rate at the bank and having the bank lend her the funds at a​ 10% interest rate rather than lend her the funds​ yourself?

a. Your neighbor suffers from information asymmetry.

b. There will always be a moral hazard problem in lending to a friend or neighbor.

c. There is no way to diversify your savings except with the help of a bank.

d. The costs of writing up the loan contract might exceed the​ 5% difference between your deposit rate and the bank lending rate.

Answer 1

Answer

The correct answer is (d) The costs of writing up the loan contract might exceed the​ 5% difference between your deposit rate and the bank lending rate.

In order to make secured loan you must have to write up loan contract, incur some other legal fees, etc. Hence the total cost required to make this loan can exceed the extra interest rate that they can earn by direct lending to the neighbor. Hence, in order to make loan to a neighbor at 10% interest rate is less profitable than saving in the bank at 5% interest rate.

Hence, the correct answer is (d) The costs of writing up the loan contract might exceed the​ 5% difference between your deposit rate and the bank lending rate.